Global Investment Outlook

THE GLOBAL
INVESTMENT
OUTLOOK
RBC GAM Investment Strategy Committee
SUMMER 2018
THE RBC GAM INVESTMENT
STRATEGY COMMITTEE
The RBC GAM Investment Strategy Committee These include:
consists of senior investment professionals ●● the recommended mix of cash, fixed income
drawn from all areas of RBC GAM. The Committee instruments, and equities
regularly receives economic and capital
●● the recommended global exposure of fixed
markets related input from internal and external
income and equity portfolios
sources. Important guidance is provided by the
Committee’s regional equity advisors (North ●● the optimal term structure for fixed income
America, Europe, Asia, Emerging Markets) and investments
from the Global Fixed Income & Currencies ●● the suggested sector and geographic make-up
sub-committee. From this, the Committee builds within equity portfolios
a detailed global investment forecast looking one ●● the preferred exposure to major currencies
year forward.
Results of the Committee’s deliberations are
The Committee’s view includes an assessment published quarterly in The Global Investment
of global fiscal and monetary conditions, Outlook.
projected economic growth and inflation, as well
as the expected course of interest rates, major
currencies, corporate profits and stock prices.
From this global forecast, the RBC GAM

Investment Strategy Committee develops
specific guidelines that can be used to manage
portfolios.
CONTENTS
EXECUTIVE SUMMARY 2 CURRENCY MARKETS 51

The Global Investment Outlook Dagmara Fijalkowski, MBA, CFA – Head,
Global Fixed Income and Currencies,
Eric Savoie, MBA, CFA – Senior Analyst, Investment Strategy, RBC Global Asset Management Inc.
RBC Global Asset Management Inc.
Daniel Mitchell, CFA – Portfolio Manager,
Daniel E. Chornous, CFA – Chief Investment Officer, RBC Global Asset Management Inc.
REGIONAL EQUITY MARKET OUTLOOK

ECONOMIC & CAPITAL MARKETS FORECASTS 4
RBC GAM Investment Strategy Committee United States 58
Brad Willock, CFA – V.P. & Senior Portfolio Manager,
RECOMMENDED ASSET MIX 5
RBC GAM Investment Strategy Committee Canada 60
Sarah Neilson, CFA – Portfolio Manager,
CAPITAL MARKETS PERFORMANCE 10 RBC Global Asset Management Inc.
Irene Fernando, CFA – Portfolio Manager,
Milos Vukovic, MBA, CFA – V.P. & Head of Investment Policy,
Europe 62
GLOBAL INVESTMENT OUTLOOK 13 David Lambert – Senior Portfolio Manager,
RBC Global Asset Management (UK) Limited
Macro and markets: Down, but not out
Eric Lascelles – Chief Economist, Asia 64
RBC Global Asset Management Inc. Derek Au – Research Analyst,
Eric Savoie, MBA, CFA – Senior Analyst, Investment Strategy, RBC Investment Management (Asia) Limited
Daniel E. Chornous, CFA – Chief Investment Officer, Emerging Markets 66
RBC Global Asset Management Inc. Philippe Langham – Head & Senior Portfolio Manager,
Emerging Market Equities
GLOBAL FIXED INCOME MARKETS
The bond-market outlook 46 RBC GAM INVESTMENT STRATEGY COMMITTEE 68
Soo Boo Cheah, MBA, CFA – Senior Portfolio Manager,
Taylor Self, MBA – Analyst,
Direction of rates 48
Soo Boo Cheah, MBA, CFA – Senior Portfolio Manager,
Suzanne Gaynor – V.P. & Senior Portfolio Manager,
THE GLOBAL INVESTMENT OUTLOOK Summer 2018 I 1

EXECUTIVE SUMMARY
Solid economic growth in sight implement fiscal stimulus, and that

Eric Savoie, MBA, CFA The global economy is being structural reforms in Japan deliver
Senior Analyst, Investment Strategy significantly more growth than we
RBC Global Asset Management Inc. buoyed by a variety of tailwinds. The
most prominent is fiscal stimulus had forecast.
Daniel E. Chornous, CFA
which, while mostly a U.S. story,
Chief Investment Officer Expecting further U.S.-dollar
RBC Global Asset Management Inc. could extend to other developed
regions such as the U.K., Japan and strength
Germany over the next few years. The U.S. dollar has resumed its
Financial markets were Supporting our above-consensus upward trend after declining for
view on developed-market growth are more than a year. The trade-weighted
more volatile in the first
elevated levels of optimism among greenback has risen by 5% since
half of 2018 as enthusiasm businesses and consumers, the early April and, in our view, has the
following U.S. tax cuts diminishing drag from the financial potential for more upside. Three
was met with concerns crisis and a boost from many years of main factors support further dollar
around protectionism, ultra-low interest rates. In emerging strength. First, the dollar has yet
markets, we expect growth to be a bit to reach excessive valuation levels
higher inflation and tighter
below consensus but double that in in the current cycle. Second, U.S.
financial conditions. the developed world. Our forecast is interest rates are more attractive
Although economic growth for the global economy to expand by than in other developed regions and
has slowed, it remains 4.0% in both 2018 and 2019, which are expected to increase at a faster
would be the fastest rate since 2010. pace. Third, the U.S. is enjoying
quite good by post-crisis
better economic momentum relative
standards. A variety of risks could impact to other major economies. Our
our positive view 12-month forecasts suggest the
The key risks to our outlook relate to dollar will be strongest against the
escalating protectionist actions, the British pound and the Canadian
aging business cycle and tightening dollar, while the euro and yen should
financial conditions. Also on the list fare better. With these forecasts, we
are geopolitical risks, particularly remain much more bullish on the
given the unpredictable nature of U.S. dollar than the consensus.
U.S. foreign policy, as it relates to
negotiations with North Korea and Firming inflation appears
sanctions against Iran. In Europe, manageable
rising nationalist sentiment and Inflation is transitioning to normal
political challenges in Italy and Spain levels after an extended period of
are concerning. While the list of too low inflation or even deflation.
threats is constantly evolving, some A business cycle in its later stages
issues could turn out more positive and a rapid increase in oil prices
than anticipated. These include the could push inflation briefly towards
possibility that the speed limit on 3.0% in the near term. However, a
global growth rises more than we surge in consumer prices is unlikely
had expected, that more countries to be sustained into 2019 as other
2 I THE GLOBAL INVESTMENT OUTLOOK Summer 2018

Executive Summary | Eric Savoie, MBA, CFA | Daniel E. Chornous, CFA
forces indicate inflation should be adjustments can be gradual and deliver double-digit returns this year
in the range of 2.0% to 2.5%. The distributed over an extended period. and next. We acknowledge, however,
increase in oil prices in 2018 versus The current yield on the U.S. 10-year that any deterioration in the outlook
2017 is also not expected to repeat Treasury is close to our modelled for earnings would leave markets
next year, and a number of structural level of equilibrium, but that level vulnerable to correction given
factors related to demographics, increases over time paced by an currently demanding valuations.
globalization and technological increase in real (after-inflation)
change will continue to suppress interest rates. The financial crisis Maintaining modest
developed-world inflation. In the and unorthodox central-bank policy underweight bonds/
end, we look for rising developed- reduced real interest rates to levels overweight stocks
world inflation and hold a slightly that were unsustainably low and
Balancing the risks and opportunities
above-consensus view, but not to the investors are now starting to demand
in the short and long term, we feel
extent that inflation is set to become a higher real return on their savings
it is still appropriate for a balanced
a problem. as memories of the crisis fade. Our
investor to maintain a bias toward
models assume real interest rates
risk assets. Solid global growth
Central banks determined to ultimately revert to their 40-year
should support higher interest rates
dial back accommodation average, with the increase being
and corporate profits. The former
Moderate growth and firming evenly distributed over many years.
will act as a headwind to bond
inflation will encourage central A sustained rise in bond yields, even
returns and the latter should support
banks to continue dialing back if gradual, would act as a headwind
equity prices. However, given the
accommodative monetary policies. for sovereign-bond investments
maturation of the business cycle and
The U.S. Federal Reserve is the and lead to low, or even negative,
the other potential risks to our base
furthest along and is now in the total returns.
case, we feel it is prudent to reduce
process of shrinking its balance the degree of risk-taking in our
sheet. The Bank of Canada and the Bull market in stocks can portfolios. We remain underweight
Bank of England have also joined resume as long as earnings fixed income, but less so than at
the tightening trend, but less so. come through previous points in the cycle, since
Even with these actions, policy rates Global equities have fluctuated bonds should serve as ballast in a
remain historically low. This is partly significantly in the past quarter balanced portfolio if equities run
because the European Central Bank and were essentially directionless into turbulence or the economy
and Bank of Japan still have negative as rapid corporate profit growth downshifts. We have also been
interest rates, but also because was offset by contracting price-to- reducing our equity weight from
today’s high debt levels mean earnings ratios. Expanding valuations the substantial overweights held in
neutral policy rates are now lower have been a significant source of prior quarters/years to more modest
than they’ve been in the past. Rate gains for stocks during this long levels. In our view, the fact that our
hikes will indeed act as a headwind bull market, but sustained earnings indicators suggest little chance of
to economic growth, but gradual growth will be critical to drive stocks recession over our 1-year forecast
central-bank tightening is justified in higher from here. Earnings have horizon, combined with the potential
this environment. indeed been growing rapidly, helped upside in corporate profits, still
in part by the tax cuts. In the first justifies a mild overweight in stocks.
Rising bond yields could grind quarter, earnings grew 26% on a For a balanced, global investor, we
on fixed-income returns for year-over-year basis and revenues currently recommend an asset mix
many years climbed 8%. Analysts expect the of 58% equities (strategic neutral
Our model for the U.S. 10-year bond positive trend in earnings to persist position: 55%) and 40% fixed
suggests an upward bias to yields and our scenario analysis suggests a income (strategic neutral position:
over the long term, but also that reasonable outcome is for stocks to 43%), with the balance in cash.

ECONOMIC & CAPITAL MARKETS FORECASTS
Economic forecast (RBC GAM Investment Strategy Committee)

UNITED UNITED EMERGING
STATES CANADA EUROPE KINGDOM JAPAN CHINA MARKETS*
Change Change Change Change Change Change Change
from from from from from from from
Summer Spring Summer Spring Summer Spring Summer Spring Summer Spring Summer Spring Summer Spring
2018 2018 2018 2018 2018 2018 2018 2018 2018 2018 2018 2018 2018 2018
REAL GDP
2017A 2.27% 3.00% 2.50% 1.85% 1.71% 6.86% 5.41%
2018E 3.00% N/C 1.75% N/C 2.25% N/C 1.50% N/C 1.50% N/C 6.50% 0.25 5.50% N/C
2019E 2.75% N/C 1.50% N/C 1.75% N/C 1.50% N/C 1.25% N/C 6.25% 0.25 5.50% N/C
CPI
2017A 2.14% 1.61% 1.53% 2.68% 0.44% 1.52% 2.51%
2018E 2.50% 0.25 2.25% N/C 1.50% N/C 2.50% (0.25) 1.25% N/C 2.25% N/C 3.25% N/C
2019E 2.25% N/C 2.00% N/C 1.75% N/C 2.25% (0.25) 1.50% 0.25 2.50% N/C 3.25% N/C
* .
A = Actual E = Estimate GDP Weighted Average of China, India, South Korea, Brazil, Mexico and Russia .
Targets (RBC GAM Investment Strategy Committee)

FORECAST CHANGE FROM 1-YEAR TOTAL RETURN
MAY 2018 MAY 2019 SPRING 2018 ESTIMATE* (%)
CURRENCY MARKETS AGAINST USD
CAD (USD–CAD) 1.30 1.35 N/C (4.5)
EUR (EUR–USD) 1.17 1.17 N/C (2.7)
JPY (USD–JPY) 108.81 102.00 (3.00) 4.1
GBP (GBP–USD) 1.33 1.25 0.05 (7.6)
FIXED INCOME MARKETS
U.S. Fed Funds Rate 1.75 2.50 0.13 N/A
U.S. 10-Year Bond 2.86 3.00 N/C 1.7
Canada Overnight Rate 1.25 1.75 N/C N/A
Canada 10-Year Bond 2.24 2.50 N/C 0.0
Eurozone Deposit Facility Rate -0.40 -0.40 N/C N/A
Germany 10-Year Bund 0.34 0.75 (0.25) (5.9)
U.K. Base Rate 0.50 0.75 N/C N/A
U.K. 10-Year Gilt 1.23 1.75 N/C (3.5)
Japan Overnight Call Rate -0.05 -0.10 N/C N/A
Japan 10-Year Bond 0.04 0.10 N/C (0.6)
EQUITY MARKETS
S&P 500 2705 2925 25 10.1
S&P/TSX Composite 16062 16750 500 7.2
MSCI Europe 129 139 N/C 11.2
FTSE 100 7678 8250 550 11.7
Nikkei 22202 24650 650 13.0
MSCI Emerging Markets 1121 1250 (50) 14.4
*Total returns are expressed in local currencies with the exception of MSCI Emerging Markets whose return is expressed in USD.

RECOMMENDED ASSET MIX
Asset mix – the allocation within portfolios to stocks, expectations for the major asset classes. These weights
bonds and cash – should include both strategic and are further divided into recommended exposures to the
tactical elements. Strategic asset mix addresses the blend variety of global fixed income and equity markets. Our
of the major asset classes offering the risk/return tradeoff recommendation is targeted at the Balanced profile where
best suited to an investor’s profile. It can be considered the benchmark setting is 55% equities, 43% fixed income,
to be the benchmark investment plan that anchors a 2% cash.
portfolio through many business and investment cycles,
independent of a near-term view of the prospects for the A tactical range of +/- 15% around the benchmark
economy and related expectations for capital markets. position allows us to raise or lower exposure to specific
Tactical asset allocation refers to fine tuning around asset classes with a goal of tilting portfolios toward
the strategic setting in an effort to add value by taking those markets that offer comparatively attractive near-
advantage of shorter term fluctuations in markets. term prospects.
Every individual has differing return expectations and This tactical recommendation for the Balanced profile can
tolerances for volatility, so there is no “one size fits all” serve as a guide for movement within the ranges allowed
strategic asset mix. Based on a 40-year study of historical for all other profiles.
returns1 and the volatility2 of returns (the range around The value-added of tactical strategies is, of course,
the average return within which shorter-term results dependent on the degree to which the expected
tend to fall), we have developed five broad profiles and scenario unfolds.
assigned a benchmark strategic asset mix for each. These
profiles range from very conservative through balanced to Regular reviews of portfolio weights are essential to
aggressive growth. It goes without saying that as investors the ultimate success of an investment plan as they
accept increasing levels of volatility, and therefore greater ensure current exposures are aligned with levels of
risk that the actual experience will depart from the longer- long-term returns and risk tolerances best suited to
term norm, the potential for returns rises. The five profiles individual investors.
presented below may assist investors in selecting a
strategic asset mix best aligned to their investment goals. Anchoring portfolios with a suitable strategic asset mix,
and placing boundaries defining the allowed range for
Each quarter, the RBC GAM Investment Strategy tactical positioning, imposes discipline that can limit
Committee publishes a recommended asset mix damage caused by swings in emotion that inevitably
based on our current view of the economy and return accompany both bull and bear markets.
1
Average return: The average total return produced by the asset class over the period 1978 – 2018, based on monthly results.
2
Volatility: The standard deviation of returns. Standard deviation is a statistical measure that indicates the range around the average
return within which 2/3 of results will fall into, assuming a normal distribution around the long-term average.

Recommended Asset Mix
GLOBAL ASSET MIX

BENCHMARK PAST SUMMER FALL NEW YEAR SPRING SUMMER
POLICY RANGE 2017 2017 2018 2018 2018
CASH 2.0% 1.0% – 16% 3.0% 3.0% 3.0% 2.0% 2.0%
BONDS 43.0% 25.0% – 54.0% 38.0% 39.0% 39.0% 40.0% 40.0%
STOCKS 55.0% 36.0% – 65.0% 59.0% 58.0% 58.0% 58.0% 58.0%

Note: Effective September 1, 2014, we revised our strategic neutral positions within fixed income, lowering the ‘neutral’ commitment to cash from 5% to
2%, and moving the difference to bonds. This takes advantage of the positive slope of the yield curve which prevails over most time periods, and allows
our fixed income managers to shorten duration and build cash reserves whenever a correction in the bond market, or especially an inverted yield curve,
is anticipated.
REGIONAL ALLOCATION
CWGBI* PAST SUMMER FALL NEW YEAR SPRING SUMMER
GLOBAL BONDS MAY 2018 RANGE 2017 2017 2018 2018 2018
North America 38.8% 18% – 44% 44.3% 34.1% 37.1% 43.5% 43.8%
Europe 41.2% 32% – 56% 34.1% 40.4% 38.1% 36.7% 36.2%
Asia 20.0% 17% – 35% 21.6% 25.5% 24.7% 19.8% 20.0%
Note: Past Range reflects historical allocation from Fall 2002 to present.
MSCI** PAST SUMMER FALL NEW YEAR SPRING SUMMER

GLOBAL EQUITIES MAY 2018 RANGE 2017 2017 2018 2018 2018
North America 61.0% 51% – 62% 59.9% 59.9% 60.0% 60.0% 61.5%
Europe 20.3% 19% – 35% 21.3% 20.6% 20.6% 20.2% 18.5%
Asia 11.5% 9% – 18% 11.4% 12.0% 11.9% 12.4% 12.5%
Emerging Markets 7.3% 0% – 8.5% 7.5% 7.5% 7.5% 7.5% 7.5%
Our asset mix is reported as at the end of each quarter. The mix is fluid and may be adjusted within each quarter, although we do not always report on
shifts as they occur. The weights in the table should be considered a snapshot of our asset mix at the date of release of the Global Investment Outlook.
GLOBAL EQUITY SECTOR ALLOCATION

MSCI** RBC GAM ISC RBC GAM ISC CHANGE FROM WEIGHT VS.
MAY 2018 SPRING 2018 SUMMER 2018 SPRING 2018 BENCHMARK
Energy 6.57% 5.11% 6.57% 1.46 100.0%

Materials 5.14% 5.24% 6.14% 0.89 119.5%
Industrials 11.45% 11.69% 10.25% (1.44) 89.5%
Consumer Discretionary 12.81% 13.67% 14.81% 1.14 115.6%
Consumer Staples 8.03% 8.78% 7.03% (1.75) 87.5%
Health Care 11.73% 13.74% 11.73% (2.01) 100.0%
Financials 17.65% 19.38% 18.65% (0.73) 105.7%
Information Technology 18.04% 18.91% 20.04% 1.14 111.1%
Telecom. Services 2.59% 1.69% 0.59% (1.10) 22.7%
Utilities 2.99% 0.83% 2.49% 1.66 83.3%
Real Estate 3.00% 0.96% 1.70% 0.74 56.7%
*FTSE World Government Bond Index **MSCI World Index Source: RBC GAM Investment Strategy Committee

“ At RBC GAM, we have a team dedicated to setting and

reviewing the strategic asset mix for all of our multi-asset solutions. With
an emphasis on consistency of returns, risk management and capital
preservation, we have developed a strategic asset allocation framework for
five client risk profiles that correspond to broad investor objectives and risk
preferences. These five profiles range from Very Conservative through
”
Balanced to Aggressive Growth.
VERY CONSERVATIVE
BENCH- LAST CURRENT
Very Conservative investors will
ASSET CLASS MARK RANGE QUARTER RECOMMENDATION seek income with maximum capital
Cash & Cash Equivalents 2% 0-15% 2.0% 2.0% preservation and the potential for modest
Fixed Income 78% 55-95% 75.0% 75.0% capital growth, and be comfortable with
Total Cash & Fixed Income 80% 65-95% 77.0% 77.0% small fluctuations in the value of their
Canadian Equities 10% 5-20% 10.8% 11.3% investments. This portfolio will invest
U.S. Equities 5% 0-10% 6.3% 6.1% primarily in fixed-income securities, and
International Equities 5% 0-10% 5.9% 5.6% a small amount of equities, to generate
Emerging Markets 0% 0% 0.0% 0.0% income while providing some protection
Total Equities 20% 5-35% 23.0% 23.0%
against inflation. Investors who fit
this profile generally plan to hold their
RETURN VOLATILITY investment for the short to medium term
40-Year Average 8.6% 5.5% (minimum one to five years).
Last 12 Months 0.8% 3.5%

CONSERVATIVE
BENCH- LAST CURRENT
Conservative investors will pursue
ASSET CLASS MARK RANGE QUARTER RECOMMENDATION modest income and capital growth with
2% 0-15%
Cash & Cash Equivalents 2.0% 2.0% reasonable capital preservation, and be
Fixed Income 63% 40-80% 59.9% 59.9% comfortable with moderate fluctuations
Total Cash & Fixed Income 65% 50-80% 61.9% 61.9% in the value of their investments. The
Canadian Equities 15% 5-25% 15.8% 16.2%
portfolio will invest primarily in fixed-
U.S. Equities 10% 0-15% 11.3% 11.2%
income securities, with some equities, to
International Equities 10% 0-15% 11.0% 10.7%
achieve more consistent performance and
Emerging Markets 0% 0% 0.0% 0.0%
provide a reasonable amount of safety.
Total Equities 35% 20-50% 38.1% 38.1%
The profile is suitable for investors who
RETURN VOLATILITY plan to hold their investment over the
40-Year Average 8.9% 6.5% medium to long term (minimum five to
Last 12 Months 2.1% 3.6% seven years).
BALANCED
The Balanced portfolio is appropriate
BENCH- LAST CURRENT
ASSET CLASS MARK RANGE QUARTER RECOMMENDATION for investors seeking balance between
Cash & Cash Equivalents 2% 0-15% 2.0% 2.0% long-term capital growth and capital
Fixed Income 43% 20-60% 40.0% 40.0% preservation, with a secondary focus on
Total Cash & Fixed Income 45% 30-60% 42.0% 42.0% modest income, and who are comfortable
Canadian Equities 19% 10-30% 19.7% 20.0% with moderate fluctuations in the value
U.S. Equities 20% 10-30% 21.2% 21.3% of their investments. More than half the
International Equities 12% 5-25% 12.8% 12.4% portfolio will usually be invested in a
Emerging Markets 4% 0-10% 4.3% 4.3% diversified mix of Canadian, U.S. and
Total Equities 55% 40-70% 58.0% 58.0% global equities. This profile is suitable
RETURN VOLATILITY
for investors who plan to hold their
40-Year Average 9.3% 7.7% investment for the medium to long term
Last 12 Months 4.2% 4.1% (minimum five to seven years).

GROWTH
BENCH- LAST CURRENT
Investors who fit the Growth profile
ASSET CLASS MARK RANGE QUARTER RECOMMENDATION will seek long-term growth over capital
2% 0-15%
Cash & Cash Equivalents 2.0% 2.0% preservation and regular income, and
Fixed Income 28% 5-40% 24.9% 24.9% be comfortable with considerable
Total Cash & Fixed Income 30% 15-45% 26.9% 26.9% fluctuations in the value of their
Canadian Equities 23% 15-35% 23.7% 24.0%
investments. This portfolio primarily
U.S. Equities 25% 15-35% 26.2% 26.3%
holds a diversified mix of Canadian, U.S.
International Equities 16% 10-30% 16.8% 16.4%
and global equities and is suitable for
Emerging Markets 6% 0-12% 6.4% 6.4%
investors who plan to invest for the long
Total Equities 70% 55-85% 73.1% 73.1%
term (minimum seven to ten years).
RETURN VOLATILITY
40-Year Average 9.5% 9.4%

AGGRESSIVE GROWTH
BENCH- LAST CURRENT
Aggressive Growth investors seek
ASSET CLASS MARK RANGE QUARTER RECOMMENDATION maximum long-term growth over capital
2% 0-15%
Cash & Cash Equivalents 2.0% 2.0% preservation and regular income, and are
Fixed Income 0% 0-10% 0.0% 0.0% comfortable with significant fluctuations
Total Cash & Fixed Income 2% 0-20% 2.0% 2.0% in the value of their investments. The
Canadian Equities 32.5% 20-45% 32.2% 32.5% portfolio is almost entirely invested in
U.S. Equities 35.0% 20-50% 35.3% 35.5%
stocks and emphasizes exposure to
International Equities 21.5% 10-35% 21.3% 20.8%
global equities. This investment profile
Emerging Markets 9.0% 0-15% 9.2% 9.2%
is suitable only for investors with a high
Total Equities 98% 80-100% 98.0% 98.0%
risk tolerance and who plan to hold their
RETURN VOLATILITY
investments for the long term (minimum
40-Year Average 10.1% 12.0% seven to ten years).

CAPITAL MARKETS PERFORMANCE
dropped 0.3%, and the Barclays the MSCI France gained 9.5% and
Milos Vukovic, MBA, CFA Capital Aggregate Bond Index, the MSCI U.K. returned 8.9%, all
V.P. & Head of Investment Policy the U.S. fixed-income benchmark, in U.S. dollar terms. The S&P/TSX
gained 0.6%. Government-bond Composite Index gained 3.7% in
markets in Europe and Japan fell U.S.-dollar terms during the three
3.8% and 1.5%, respectively, in U.S.- months. For the 12-month period,
The U.S. dollar rose against all four
dollar terms, measured by the FTSE the Canadian benchmark index
major currencies during the three-
WGBI – Europe Index and the FTSE gained 12.3%.
month period ended May 31, 2018,
Japanese Government Bond Index.
driven by stronger relative domestic Over the past year, growth stocks in
growth and interest rates. The Global equities were mixed during the U.S. outperformed value stocks.
greenback climbed 4.4% versus the the three-month period, rising in The Russell 3000 Growth Index
euro and 3.6% versus the British Canada, the U.S. and the U.K., and gained 21.3%, while the Russell
pound. The U.S. dollar recorded falling in other markets due to the 3000 Value Index returned 8.9%.
gains of 2.0% against the yen and strong greenback. The small-cap
1.0% versus the Canadian dollar. For and mid-cap U.S. benchmarks Just five of the 11 global equity
the latest 12-month period, the U.S. outperformed their large cap sectors recorded gains in the
dollar declined across the board, counterparts significantly. The S&P quarter ending May 31, 2018. The
falling 4.0% versus the Canadian 500 Index rose 0.2%, while the best-performing sector was Energy
dollar and 3.9% against the euro. MSCI Europe Index fell 1.8% and with a return of 12.7%, followed
The decline was 3.1% versus the the MSCI Japan Index dropped 2.4% by Utilities, which rose 4.4%, and
pound and 1.8% versus the yen. in U.S.-dollar terms. The MSCI U.K. Real Estate with a 3.9% gain. The
rose 3.6%, while the MSCI Germany worst-performing sector over the
Major global fixed-income markets three-month period was Financials,
declined 3.5%. The MSCI France lost
outside North America fell during the which lost 6.5%, followed by
0.9%. Over the 12-month period,
three-month period due mostly to Telecommunication Services and
the S&P 500 gained 14.4% and the
the rise in the U.S. dollar. The FTSE Consumer Staples, which declined
MSCI Japan rose 14.6%. In Europe,
TMX Canada Universe Bond Index, 4.9% and 3.3% respectively.
the MSCI Germany returned 4.0%,
Canada’s fixed-income benchmark,

Capital Markets Performance | Milos Vukovic, MBA, CFA
EXCHANGE RATES
Periods ending May 31, 2018
Current 3 months YTD 1 year 3 years 5 years
USD (%) (%) (%) (%) (%)
USD–CAD 1.2966 1.04 3.15 (4.02) 1.40 4.57
USD–EUR 0.8554 4.36 2.63 (3.91) (2.06) 2.14
USD–GBP 0.7522 3.56 1.56 (3.08) 4.76 2.71
USD–JPY 108.7850 1.96 (3.45) (1.77) (4.30) 1.60
Note: all changes above are expressed in US dollar terms
CANADA
USD CAD
3 months YTD 1 year 3 years 5 years 3 months 1 year 3 years
Fixed Income Markets: Total Return (%) (%) (%) (%) (%) (%) (%) (%)
FTSE TMX Canada Univ. Bond Index TR (0.34) (3.02) 3.16 0.19 (1.56) 0.70 (0.98) 1.59
U.S.
USD CAD
FTSE U.S. Government TR 0.63 (1.49) (0.40) 1.40 1.99 1.27 (4.78) 2.68
Barclays Capital Agg. Bond Index TR 0.61 (1.50) (0.37) 1.39 1.98 1.66 (4.38) 2.81
GLOBAL
USD CAD
FTSE WGBI TR (1.32) (1.28) 1.64 2.53 1.36 (0.69) (2.83) 3.83
FTSE European Government TR (3.80) (2.66) 4.06 2.68 1.50 (2.79) (0.12) 4.12
FTSE Japanese Government TR (1.54) 4.26 2.81 6.77 0.81 (0.51) (1.32) 8.26
CANADA
USD CAD
Equity Markets: Total Return (%) (%) (%) (%) (%) (%) (%) (%)
S&P/TSX Composite 3.74 (2.81) 12.26 3.91 3.32 4.83 7.75 5.36
S&P/TSX 60 3.77 (2.84) 12.59 4.49 3.98 4.85 8.07 5.95
S&P/TSX Small Cap 4.50 (4.37) 10.67 3.67 0.93 5.59 6.23 5.12
U.S.
USD CAD
S&P 500 TR 0.19 2.02 14.38 10.97 12.98 1.23 9.79 12.53
S&P 400 TR 4.82 3.05 14.86 10.25 12.17 5.92 10.24 11.79
S&P 600 TR 9.75 8.17 22.72 13.80 14.31 10.89 17.79 15.39
Russell 3000 Value TR (0.14) (1.43) 8.85 7.71 10.15 0.90 4.48 9.22
Russell 3000 Growth TR 2.32 6.43 21.32 13.69 15.51 3.39 16.45 15.28
NASDAQ Composite Index TR 2.33 7.80 20.06 13.65 16.58 3.39 15.24 15.24
Note: all rates of return presented for periods longer than 1 year are annualized Source: Bloomberg/MSCI

Capital Markets Performance | Milos Vukovic, MBA, CFA
GLOBAL
USD CAD
MSCI World TR * (0.44) 0.48 11.57 7.65 9.40 0.80 7.15 9.04
MSCI EAFE TR * (1.82) (1.55) 7.97 4.33 5.93 (0.60) 3.70 5.67
MSCI Europe TR * (1.80) (2.58) 4.83 3.37 5.30 (0.59) 0.68 4.71
MSCI Pacific TR * (1.91) 0.21 13.97 6.30 7.15 (0.70) 9.46 7.67
MSCI UK TR * 3.59 (0.08) 8.93 2.18 4.02 4.87 4.62 3.50
MSCI France TR * (0.93) 0.87 9.51 8.05 7.37 0.29 5.18 9.44
MSCI Germany TR * (3.48) (5.15) 3.95 5.17 6.03 (2.29) (0.17) 6.53
MSCI Japan TR * (2.43) 0.51 14.57 6.54 8.29 (1.22) 10.03 7.91
MSCI Emerging Markets TR * (5.76) (2.61) 14.03 6.17 4.52 (4.59) 9.51 7.54
GLOBAL EQUITY SECTORS

USD CAD
Sector: Total Return (%) (%) (%) (%) (%) (%) (%) (%)
Energy TR * 12.72 5.30 20.68 3.02 1.13 14.11 15.90 4.35
Materials TR * (0.62) (1.52) 17.40 7.65 6.22 0.61 12.75 9.04
Industrials TR * (2.06) (1.26) 10.48 9.58 10.18 (0.85) 6.10 11.00
Consumer Discretionary TR * 0.51 4.76 15.57 9.28 11.75 1.75 11.00 10.69
Consumer Staples TR * (3.26) (8.41) (5.84) 3.77 6.09 (2.06) (9.57) 5.10
Health Care TR * (0.68) 0.19 6.31 2.34 10.08 0.55 2.10 3.66
Financials TR * (6.46) (4.40) 11.53 7.14 8.22 (5.30) 7.11 8.53
Information Technology TR * 2.52 9.98 26.15 18.79 19.32 3.78 21.15 20.33
Telecommunication Services TR * (4.87) (9.13) (6.95) (0.52) 4.25 (3.70) (10.64) 0.76
Utilities TR * 4.39 (1.42) (1.45) 4.39 6.12 5.68 (5.35) 5.74
Real Estate TR * 3.89 (2.16) 4.60 NA NA 5.18 0.45 NA
* Net of taxes Note: all rates of return presented for periods longer than 1 year are annualized Source: Bloomberg/MSCI

GLOBAL INVESTMENT OUTLOOK
Macro and markets: Down, but not out
Eric Lascelles Exhibit 1: A tale of two very different years

Chief Economist
2900
Eric Savoie, MBA, CFA 2800
Senior Analyst, Investment Strategy Smooth and
2700 happy equities
S&P 500 Index
in 2017
2600
Chief Investment Officer 2500
RBC Global Asset Management Inc. Bumpy and less
2400 reliably cheery
in 2018
2300
The first half of 2018 has provided 2200
quite a contrast to the sunny trends Jan-17 May-17 Sep-17 Jan-18 May-18
that smiled on 2017. Last year’s silky Source: WSJ, Haver Analytics, RBC GAM
smooth markets have hit turbulence.

Economic growth has dipped and the Exhibit 2: Global manufacturing growth eases slightly
euphoria following tax cuts is now
mixed in equal parts with concern 58
57
about protectionism. Inflation 56
Expansion
Manufacturing PMI
and interest rates are no longer 55

54
at rock-bottom readings and have 53
been trending higher. Against this 52
51
backdrop, risk assets like equities 50
have struggled to make the kind of 49
48
headway that came so easily last 47 Contraction
year (Exhibit 1). 2012 2013 2014 2015 2016 2017 2018
J.P.Morgan Global PMI Developed markets PMI Emerging markets PMI
Note: PMI refers to Purchasing Managers Index for manufacturing sector, a measure for economic
But for all of these negative activity. Source: Haver Analytics, RBC GAM
developments, we ultimately
believe that macroeconomic
theoretical drags on growth, but the the “good” of fiscal stimulus is
trends and market prospects are
burden looks to be fairly small so far easily outmuscling the “bad” of
merely down rather than out. Let
and probably won’t have a materially protectionism. Higher inflation and
us start by recognizing just how
negative impact until next year. rising interest rates are entirely
unbelievably perfect, and therefore
Furthermore, we hypothesize that appropriate given the advanced
unsustainable, last year was. The
the underlying economic speed limit state of the business cycle, and
experience this year is much closer
has increased, suggesting further neither is likely to soar from here.
to the norm, and is hardly all bad.
solid growth over the remainder of
Economic growth may be slower, From an investment perspective, we
this cycle.
but it remains quite good by post- remain slightly overweight equities,
crisis standards (Exhibit 2). Higher The yin and yang of fiscal balancing the superior valuation of
interest rates, a stronger U.S. dollar stimulus versus protectionism is stocks relative to bonds with the
and increased oil prices are all a complicated one, but for now recognition that the business cycle

Global Investment Outlook | Eric Lascelles | Eric Savoie, MBA, CFA | Daniel E. Chornous, CFA
is now fairly old (Exhibit 3). Our bias

remains toward a further gradual Exhibit 3: U.S. business-cycle probabilities
reduction in risk-taking, encouraged
by the ongoing advancement of the
Most likely
business cycle. Conceivably here
here
Likelihood
Financial conditions tighten
A smaller but
Financial markets have experienced rising risk
large swings in 2018, with
particularly notable recent increases
in bond yields, oil prices and the
U.S. dollar. Beyond the obvious and
Start of cycle Early cycle Mid cycle Late cycle End of cycle Recession
immediate implications for investors
Note: Calculated via scorecard technique by RBC GAM. Source: RBC GAM
positioned in these assets, the
swings also affect the economy.
Higher yields exert a universal
Exhibit 4: Global financial conditions deteriorate, but still loose
economic drag, higher oil is bad for
some countries and good for others, 105
while a stronger U.S. dollar hurts
104
Goldman Sachs Financial
U.S. competitiveness but is helpful

103
Conditions Index
for everyone else. Tight conditions

102
Financial-conditions indexes 101
helpfully combine these various
100
financial-market perturbations
99
into a single economy-relevant Easy conditions
metric. Financial conditions have 98

2004 2006 2008 2010 2012 2014 2016 2018
indisputably tightened in 2018, U.S. Global
but only enough to unwind about Source: Goldman Sachs, Bloomberg, RBC GAM
half of the easing that took place

in 2017 (Exhibit 4). On an absolute
basis, financial conditions are still Exhibit 5: U.S. Treasury yields on the rise
reasonably friendly to growth,
5.5
though given the lags involved their
U.S. 10-year Treasury yield (%)
5.0
recent turn may start to bite a bit ...Another
4.5 100 bps increase
more in 2019. 4.0
since
Sep 2017
Yields surged over 120
3.5 bps in six months...
The increase in interest rates is
3.0
an unambiguous economic drag.
2.5
Yields are almost universally higher,
2.0
with the benchmark U.S. 10-year
1.5
yield up considerably (Exhibit 5).
1.0
Further modest gains are likely, but 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
high global debt loads ultimately Source: U.S. Department of the Treasury, Haver Analytics, RBC GAM

limit how much further yields can

advance from here. Exhibit 6: Libor-OIS spread is wider than normal
The increase in borrowing costs 60

is even more substantial for the
USD Libor-OIS spread (bps)

50
several trillion dollars of loans that
are linked to the LIBOR rate, which 40
has increased considerably (Exhibit 30

6). Fortunately, in contrast to the
ominous signal it sent during the 20
financial crisis of 2008-2009, a 10

wider LIBOR spread has more to do
0
with technical gremlins than with 2010 2011 2012 2013 2014 2015 2016 2017 2018
bank-solvency concerns (though Source: Bloomberg, RBC GAM
LIBOR-linked borrowing costs are
nevertheless higher all the same).
For now, home-buying aspirations Exhibit 7: U.S. home purchase intentions fine but rates now rising
remain mostly intact, though a slight
retreat is visible (Exhibit 7). 10
% of respondents planning to buy a
9
Higher oil prices are a theoretical
home in next six months
8 Pre-crisis average
drag on global growth, though the
7
limited boost resulting from low oil
prices in 2015-2016 has called into 6
question the strength of the effect 5 Noise or

higher
in both directions. As such, we 4 rates?
don’t budget for too much economic
3
damage from higher oil prices. Yes, 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Note: Pre-crisis average from year 2000 to 2006. Source: The Conference Board Consumer
U.S. consumers will be hurt, but Confidence Survey, RBC GAM
oil-oriented businesses will benefit
enough to mostly offset this effect.
be limited in the sense that recent From a U.S. fiscal perspective, the
By virtue of its shale-oil boom, the
dollar strength has unwound only a combination of a post-election
U.S. is transitioning from a period
fraction of the dollar weakness that confidence boost, deregulation,
when high oil prices were a clear
dominated 2017. tax cuts and expanded government
negative to one in which they have
spending add up to a significant
more ambiguous implications.
The Eurozone and Japan are clearly
Fiscal stimulus helps – 0.7 percentage point boost to U.S.
hurt by higher oil prices, while at a cost 2018 growth (Exhibit 8). The boost
Fiscal stimulus remains a key is set to be smaller in 2019 at 0.3
Canada benefits.
support for economic growth. This is percentage point. The benefit to the
Recent U.S.-dollar strength delivers mostly a U.S. phenomenon, but also U.S. corporate sector is several times
a competitiveness blow to the U.S. plausible in such developed nations bigger and even more front-loaded
economy and furthermore reduces as the U.K., Japan and Germany over given the centrality of corporate-tax
the value of U.S. corporations’ the next few years. cuts to the mix.
foreign earnings. But the pain should

From a longer-term perspective,

however, a few serious offsets Exhibit 8: Effect of Trump policies on U.S. GDP
emerge. First, various fiscal-policy-
1.4 +1.2
related economic drags start to
1.2
accrue in the U.S. at a later date. 1.0
Negative economic effect on GDP
Beginning in 2020, we look for 0.8
Percentage points
growth later (protectionism, less
0.6 immig., fading fiscal stimulus)
additional protectionism, diminished +0.7
0.4
immigration and the partial 0.2 +0.4
+0.3 +0.1
unwinding of tax cuts to begin 0.0
-0.2 -0.4 -0.4
relinquishing much of the extra -0.4 Positive effect on GDP growth in short run -0.5
(confidence, dereg., tax cuts, spending bill)
growth being banked today. -0.6
-0.8
2017 2018 2019 2020 2021 2022
Second, tax cuts come at the cost Cumulative effect on GDP level Effect on annual GDP growth
of additional public debt. It is Source: RBC GAM assumptions and calculations
virtually unprecedented for the U.S.
government to deliver such a large
fiscal boost when the unemployment Exhibit 9: U.S. fiscal deficit is much bigger than it should be
rate is already so low (Exhibit 9).
This is for good reason as the -12 12
Trump
-10 Vietnam stimulus
efficacy of such stimulus is reduced
U.S. unemployment rate (%)

U.S. federal budget balance
War package 10
-8 Korean
when the economy is already hot. -6 War
8
(% of GDP)
-4
While any suggestion of serious debt -2 6
troubles would be an exaggeration, 0
4
the U.S. public debt is again growing 2
4
quickly by virtue of recent fiscal CBO
2
6 forecast
largesse and also becoming more 8 0
expensive as interest rates rise. As 1948 1958 1968 1978 1988 1998 2008 2018 2028
Budget balance (LHS, inverted) Unemployment rate (RHS)
a result, the cost of servicing U.S. Source: CBO, OMB, Haver Analytics, RBC GAM
federal debt is set to double as a
fraction of GDP over the next decade
(Exhibit 10). Future governments will Exhibit 10: U.S. debt-servicing costs to rise quickly
be constrained by this development,
with less room to stimulate the 4.0
... and stayed high till
economy in subsequent downturns.
U.S. net interest payment on
3.5 early 1990s

federal debt (% of GDP)
Rising
3.0 interest
Faster economic speed limit? Interest rate surged
rates and
Trump fiscal
2.5 during 1970s
stimulus
We continue to hypothesize that stagflation...
2.0
the speed limit on developed-
1.5
world economic growth is finally
rising after a challenging decade 1.0
(Exhibit 11). Several observations 0.5

1940 1951 1962 1973 1984 1995 2006 2017 2028
nudge us in this direction, though OMB projections
Source: OMB, Haver Analytics, RBC GAM

more evidence is needed before a

definitive conclusion can be reached. Exhibit 11: Is secular stagnation ending?
First, studies of prior financial crises Passage of •• Drag from crises usually gone in a decade
have found that their negative time •• Now 10 years from onset of crisis
effects usually fade within a decade. •• Confidence finally back to pre-crisis levels
With roughly 10 years now under the Animal
•• Market-based risk appetite is high
spirits revive
bridge, it would make sense if the •• Business investment picking up
recent acceleration in growth was •• Productivity growth tentatively reviving
at least in part the sloughing-off of Higher
•• Productivity undercounted?
productivity?
financial-crisis baggage. •• IMF upgrades its potential growth estimate
Second, there is evidence that a If “YES” = faster economic speed limit

degree of optimism and risk-taking –
Source: RBC GAM
what we call animal spirits – has
returned to the economy. Consumer
and business confidence are now
Exhibit 12: Company investment intentions are up
high and measures of market-based
risk appetite are good, translating
30
into additional business-investment 35
expenditures, 6 months ahead
Eurozone corporate demand for

20
U.S. manufacturing capital
10
loans for fixed investment

plans (Exhibit 12). 25
(past 3 months, % bal)

0
15 -10
Third, productivity has been staging -20
(% bal)
5 -30
a long-awaited comeback. It still -5
-40
-50
falls well short of anything that -60
-15
could be described as impressive, -70
-25 -80
but a number of countries are 2004 2006 2008 2010 2012 2014 2016 2018
Capex: ▬ U.S. ▬ Eurozone Recession: U.S. Eurozone U.S. & Eurozone
nevertheless reporting clear gains.
Note: U.S. expected capex (% balance) is an average of the results from manufacturing outlook surveys
The IMF believes the economic conducted by Federal Reserve Banks - Dallas, Kansas, New York, Philadelphia, and Richmond.
Source: Haver Analytics, RBC GAM
speed limit for the developed world
is now notably higher than it was
several years ago (Exhibit 13).
Exhibit 13: Economic speed limit is rebounding
To be fair, all of this could yet prove
3.0
to be an illusion. But it has now
2.5 60% of
lasted long enough that we think acceleration is
2.0
it more likely than not that the structural
1.5
Percent
potential growth rate has actually

risen sustainably. And let us recall 1.0
More capital
that the outlier in all of this is not the 0.5 investment
on the way
recent acceleration in growth, but 0.0
instead the span of very slow growth
-0.5
that preceded it. 2001 2003 2005 2007 2009 2011 2013 2015 2017
TFP Capital Labor Potential growth
Note: IMF calculations for composition of growth in advanced economies. TFP is total factor
productivity, the more efficient interplay of capital and labor. Source: IMF, RBC GAM

Putting it all together

Exhibit 14: RBC GAM GDP forecast for developed markets
Our global growth forecasts for 2018
and 2019 have been raised slightly 3.5
3.00%
this quarter, mainly due to a small 3.0 2.75%
forecast upgrade for China. Global
Annual GDP growth (%)

2.5 2.25%
GDP growth appears set to expand
at around 4.0% in both years, the 2.0 1.75% 1.75%
1.50% 1.50% 1.50% 1.50%
fastest rate since 2010. 1.5 1.25%
1.0
The current year’s developed-
market outlook is supported by high 0.5
levels of consumer and business 0.0

U.S. Eurozone Canada U.K. Japan
confidence, tax cuts, the diminishing 2018 2019
drag from the financial crisis and a Source: RBC GAM
lingering boost from easy financial

conditions.
Exhibit 15: RBC GAM GDP forecast for emerging markets
Solid growth may be in the cards
8 7.25%
next year, but probably not quite 7.00%
7 6.50% 6.25%
Annual GDP growth (%)
to the standards of 2018 as the

6
lagged effect of tightening financial
5
conditions latches on.
4
3.00% 2.75% 3.00%
Our developed-world growth 3 2.50% 2.25% 2.25% 2.25%
forecasts are unchanged from 1.75%
2
last quarter, with the U.S. set 1
to lead thanks in large part to 0
India China South Korea Brazil Mexico Russia
fiscal stimulus. Overall, our
2018 2019
developed-world outlook is slightly Source: RBC GAM
above consensus, though with
considerable variation among
forecasts are also somewhat below countries, a key criticism of
individual countries. The U.S. and
the consensus (Exhibit 15). economic gains in recent decades
Japan may manage to exceed market
is that it has left many behind.
expectations in 2018, the U.K. may To be clear, the pace of emerging- There is a degree of truth to this:
meet the market, while the market economic growth is still inequality is indeed higher than it
Eurozone and Canada may miss projected to be double that of the was a generation ago. However,
them (Exhibit 14). developed world. But emerging the popular notion that the average
markets may have slightly less American household has therefore
For emerging markets, we are a little
capacity to positively surprise as key outright stagnated is mistaken.
below consensus overall. Despite
countries such as China mature. When properly measured, the
the aforementioned upgrade to our
China forecast, we remain slightly Turning from the sheer amount median American household
below consensus on Chinese growth. of economic growth toward the income has actually increased
Our Indian and Brazilian growth distribution of growth within by more than 50% since the late

1970s (Exhibit 16). This estimate

is supported by other, simpler Exhibit 16: U.S. household income stagnation is a fiction
observations such as the fact that
60
American car ownership is higher
(cumulative % change since 1979)

When measured +51%
Median U.S. household income

50 properly, median
today and the average U.S. home is household income has
40 risen substantially
more than 50% larger than it was in Adjustments:
30 -After tax and transfers
the late 1970s. -Proper inflation metric
20 -Shrinking household size
10
A bucketful of risks 0 +7%
There are a variety of risks that could -10

1979 1984 1989 1994 1999 2004 2009 2014
yet interfere with our cozy base
Traditional metric Improved metric
case forecast (Exhibit 17). Central Note: Traditional metric is U.S. median household income deflated by CPI. Improved version
among the potential negatives is deflates with PCE deflator, adjusts for a shrinking household size over time, and reports the
change in after-tax and after-transfer income. Source: CBO, Haver Analytics, RBC GAM
that trade protectionism could be
worse than we have budgeted for;
the aging business cycle could
Exhibit 17: Macro risks: A wide range of issues
finally expire; or the rising-rate/
tightening financial-conditions story
could accelerate, perhaps spurred Protectionism Aging business cycle Higher rates/
tighter FCI
Downside risks
by inflation concerns. We address

each of these risks in subsequent U.S. elections/ European
sections. Mueller populism
China growth/
Geopolitics
There are also some smaller credit
downside risks worth reckoning
Structural
Upside risks
with. U.S. political uncertainty Fiscal stimulus

Japan reforms
is high due to the basic Secular Structurally
unpredictability of President Trump, stagnation ends low inflation
a midterm election that threatens
Source: RBC GAM
to alter the political power dynamic,
and an FBI investigation that could
Exhibit 18: U.S. elections ahead
conceivably upend the president
himself. If the Democrats win 70
Mid-term elections 2018
the House of Representatives in 60
November’s midterm elections as 50 58%
53%
Probability (%)
betting markets currently anticipate, 40

Republicans
various Republican initiatives 30 (26) 20
related to immigration, deregulation 20 29%
Toss-up
and NAFTA become less likely to 10 Democrats 7
(9) 9
survive Congress (Exhibit 18). Of 0
Democrats Democrats control Predictions for Democrats
course, U.S. presidents still have control the the Senate gubernatorial control the
House elections White House
considerable sway over foreign (# of seats) after 2020 election
Note: There will be 36 gubernatorial elections in 2018. Numbers in brackets are the current number
policy and the application of tariffs. of governors affiliated with each party. One incumbent governor is an independent.
Source: Center for Politics, University of Virginia; PredictIt; RBC GAM

European political risks have risen

in part as Eastern Europe has tilted Exhibit 19: U.S. trade scenarios
toward nationalism and political
challenges have emerged again in Slightly
Scenario Worst case Negative Neutral Best case
negative
Italy and Spain – more on these in
the Eurozone section. Likelihood 20% 25% 30% 15% 10%
Geopolitical risks are high on a Trade war Substantial Small Trump Reverse Foreign
number of fronts, related in large Detail w/ blanket increase tariffs Trump barriers fall
part to the unpredictability of tariffs in tariffs persist tariffs to pressure
U.S. foreign policy, with particular
relevance to negotiations with North Economic U.S.: -1.0% U.S.: -0.3% U.S.: -0.1% U.S.: 0.0% U.S.: positive
Korea and sanctions against Iran. effect China: -1.6% China: -0.3% China: -0.1% China: 0.0% China: ?
Other oil-relevant geopolitical risks
revolve around Venezuela, Nigeria U.S. could be hit a bit
worse than China
and Libya. Long term, China’s rising Complications:
clout presents a threat to U.S.
• Most trade models say protectionism damage is fairly small (see above).
foreign-policy hegemony.
• Ossa (2015) argues standard models understate gains to trade by factor of 2-3
While the discussion so far has • Trade uncertainty likely exerting economic drag in meantime.
dwelled on downside risks, there
• Integrated U.S.-China and North American supply chains could reduce
are a few things that could unfold economic damage in short run but increase it in long run.
more positively than expected.
These include the possibility that Source: RBC GAM
the global-growth speed limit
picks up even more than we have
budgeted for, that inflation fails Exhibit 20: Key protectionist risks
to rise as much as expected, that
more countries implement fiscal
stimulus, and that Japanese reforms
significantly revive the world’s third- U.S. & Blanket
largest economy.
NAFTA China tariffs
Trade threats
Narrow deal Asymmetric access Steel, aluminum & auto
U.S. protectionism remains a key focused on autos? to China is key tariffs meant to extract
issue trade concessions
and constantly mutating risk. Our
base case outlook budgets for a mild
economic drag from protectionism, Trade war? 20% chance
but a slew of scenarios are
conceivable ranging in effect from Source: RBC GAM
quite bad to slightly positive (Exhibit

19). The worst-case scenario, with
perhaps a 20% risk, is a full-on

trade war involving tariffs on a wide

range of products and affecting Exhibit 21: NAFTA renegotiation scenarios
many countries, resulting in a big
economic hit to all involved Scenarios Odds Assumptions Economic effect
parties. Theoretically, such damage
• NAFTA scrapped Problematic: higher costs,
should fall somewhat short of a • Prior Canada-U.S. trade deal supply-chain issues
recession, but much would depend also at risk • U.S. GDP -0.4%
on how badly markets react. At • Default WTO tariffs apply • Cdn GDP -0.8%
Termination 25% • Trade war possible? 3-5x • Mex GDP -1.4%
the opposite extreme, the best worse
case scenario occurs if the U.S. • Market now thinks <10%
successfully bullies other countries chance
via the merely temporary application
• U.S. gets its way: NAFTA Negative economic effects,
of tariffs into reducing their own defanged possibly worse than killing
barriers, unshackling the world for • Trade dispute tribunals NAFTA depending on
scrapped how substantially pact is
more trade.
• Safeguard exclusions undermined
permitted
The three key protectionist U.S. wins 15% • U.S. gov’t procurement
narratives revolve around NAFTA, protected
U.S.-China trade relations and a • High U.S./N.A. domestic auto
share
series of blanket U.S. tariffs on • Sunset: Pact to be renewed
steel, aluminum and (threatened) every 5yrs
autos (Exhibit 20). The risks
• NAFTA weakened but still Moderately negative
surrounding all three have increased functional economic effects, but at
in recent months. • Increased N.A. domestic auto least uncertainty lifted
Compromise 35% share
NAFTA is suddenly looking more • 5 year review mechanism;
dairy?
complicated as deadlines are
missed, the window for political • Mix of good, bad and neutral Limited economic effect,
approval narrows due to upcoming changes ranging from slight negative
Modernize <1% • Better integration of to slight positive
elections, progress on the auto intellectual property and
file slows, and a proposed sunset modern industries
clause creates a new schism. The
• White House fails to get way; Prolonged uncertainty; no
recent expansion of U.S. steel and bluff called long-term effect
aluminum tariffs and the threat of a No change 25% • Congress disinclined to
change NAFTA
large motor-vehicle tariff could either
prod negotiations forward or cause
Source: Moody’s, RBC GAM
efforts to break down altogether.
We believe a new NAFTA deal is

truly a coin toss with a collective
50% chance though with a variety
of possible deal permutations
(Exhibit 21). Two main thoughts
support this view:

• The U.S. is likely to return its

focus to China and so conceivably Exhibit 22: U.S. slaps tariffs on imports from China
content with a small or symbolic
550
NAFTA victory, particularly in the 500
run-up to midterm elections. 450
400
Gap
350 U.S. threatens to
• We believe the NAFTA deal
US$ billions
impose tariffs on
300
China
essentially boils down to giving 250 4.3%
of
200
the U.S. auto sector a bigger 150
China's 1.0% $337B
GDP of
slice of the pie. Other issues are 100 U.S. $153B
50 GDP
ultimately less critical. 0
China's U.S. exports Gap Chinese goods
We assign a 25% chance to NAFTA exports to U.S. to China to be hit by tariffs
Services exports Goods exports  Chinese goods to be hit by tariffs
being terminated – bad for all
Note: 2017 exports shown in chart. Tariffs on China include tariffs on steel and aluminum products
parties – and at the opposite estimated based on 2017 imports and tariffs on $150 billion of goods from China announced on
April 3, 2018 and April 5, 2018. Source: U.S. Census Bureau, Haver Analytics, RBC GAM
extreme a 25% chance that the
existing NAFTA accord simply
remains in place. Of course, the
Exhibit 23: U.S. trade deficit less burdensome than it looks
uncertainty in the meantime is
problematic, chopping as much 2
1.2
as half a percentage point from
U.S. int'l transactions, 2017
1
Canadian GDP.
0
(% of GDP)
It is not surprising that China is -1

U.S. is a net debtor
now attracting a great deal of the -2 to foreigners,
yet its net investment
U.S. trade ire given the mercantilist income is positive
-3
philosophy of the present -2.9
-4
administration and the gaping
-4.2
trade imbalance between the two -5
Trade in goods balance Trade in goods & services Net investment
countries (Exhibit 22). This heated balance income
Source: BEA, Haver Analytics, RBC GAM
up in a big way over the past quarter
as the U.S. made preparations for
sizeable tariffs on more than US$50 the rapid-fire changes occurring. But emerged unscathed, deploying
billion of Chinese exports, and it is worth emphasizing that it would tariffs as a temporary means to
China readied to reciprocate in kind. take quite a significant dust-up – negotiate a competitive advantage.
A further US$100 billion in tariff well beyond current threats – to do a
large amount of economic harm. As Given all of the talk about the U.S.
threats have subsequently been
it stands now, U.S. fiscal stimulus is seeking to shrink its trade deficit, it
lobbed in each direction. The U.S.
set to generate a considerably bigger is worth reflecting on two additional
has also hobbled ZTE, a prominent
tailwind than protectionism will things. First, as the possessor
Chinese telecom company for what
subtract as a headwind in all but the of the world’s reserve currency,
the U.S. says are illicit dealings with
worst-case scenario. Further to this achieving a neutral trade balance
North Korea and Iran. Additional
point, a review of U.S. protectionist may prove hard to accomplish for
actions are entirely conceivable.
flare-ups over the past half century the U.S. Any country printing the
The trade file clearly merits close finds that the U.S. has usually world’s dominant currency enjoys
monitoring given its importance and easy access to capital, encouraging

domestic borrowing and thus

overspending. This is the very Exhibit 24: U.S. business-cycle scorecard
underpinning of a trade deficit.
Start of Early Mid Late End of
Second, the U.S. trade deficit is cycle cycle cycle cycle cycle Recession
actually sustainable indefinitely Inventories
since the effective net interest
Consumer durables
rate on all of the country’s foreign
Housing
lending is negative (Exhibit 23)!
Prices
Bonds
Late business cycle Monetary policy
We maintain our view that the U.S. Business investment
economy is at a fairly late point Leverage
in the business cycle (Exhibit 24). Equity profitability
To be clear, this is an exercise in Economic trend
probabilities rather than absolutes. Credit
Some of the inputs we use in Sentiment
reaching this view still indicate that Equity direction
the cycle is merely beginning, while Employment
others argue that we are already
Economic slack
at the end. Both views cannot be
Cycle age
correct. But the overall takeaway
Volatility
is that we are likely late in the
Votes for each stage of
economic cycle, meaning that it is 1 1.5 10.5 12 6.5 0.5
business cycle
likely within its last year or two of life. Note: Dark shading indicates the most likely stage of business cycle (full weight); light shading
indicates alternative interpretation (0.5 weight). Source: RBC GAM
While a superficial analysis of our
scorecard would appear to only
slightly favour a late-cycle claim
Exhibit 25: Economic slack finally gone in developed world
over a mid-cycle view, we prefer the
first interpretation because a) the 3
economies (% of potential GDP)
cycle indicators are clearly creeping 2 Good news:

Output gap for advanced
forward over time; and b) when - Mission accomplished!

1
taking a simpler view by dividing the
0
inputs into just two buckets, there
-1
are 50% more that argue for at least
-2
a late-cycle diagnosis as opposed to
-3 Bad news:
mid-cycle or earlier. - Higher inflation
-4 - Tighter monetary policy
A slew of metrics point to economic - Old business cycle
-5
tightness (Exhibit 25). Supporting 2004 2006 2008 2010 2012 2014 2016 2018
this assessment of a tight economy, Note: IMF estimate for 2018. Source: IMF, Haver Analytics, RBC GAM
U.S. manufacturing-overtime
hours are now running near their

highest level in a decade (Exhibit

26). This is good news in that it Exhibit 26: Manufacturing overtime highest in over a decade
means unemployment is low and
3.8
economies are back to firing on all 3.6
U.S. average weekly overtime

cylinders. But equally relevant is
manufacturing hours (hours)

3.4
that this is precisely the environment 3.2
in which inflation rises and central 3.0
banks tighten. These things are 2.8
now happening, and both are 2.6

2.4
traditional precursors to the end of
2.2
the expansion. While it might seem
2.0
strange that economic strength is 1.8
signaling the approaching end of 2006 2008 2010 2012 2014 2016 2018
Source: BLS, Haver Analytics, RBC GAM
the cycle, the simple fact is that
economies become very slippery
once they hit full capacity.
Exhibit 27: U.S. consumer-loan delinquencies creeping up
In credit markets, narrow credit
spreads plus a hint of higher 2.5
2.0
90+ days delinquent loans
delinquency rates point to an aging

(% balance normalized)
Higher than average Auto loan

1.5 delinquencies
cycle (Exhibit 27). The fraction of 1.0 deteriorating
covenant-lite loans is also high, 0.5

suggesting a degree of complacency 0.0
-0.5
in credit markets.
-1.0
-1.5 Lower than average
The state of the business cycle can
-2.0
also be assessed by a different 2001 2004 2007 2010 2013 2016 2018
methodology that attempts to Mortgages Auto loans Credit card loans
Note: Percent of balance of 90+ days delinquent loans normalized. Shaded area represents
specifically quantify the likelihood recession. Source: FRBNY Consumer Credit Panel/Equifax, Haver Analytics, RBC GAM
of a recession in the near future.
We monitor seven such models. The
good news is that none are blinking Exhibit 28: Yield-curve based U.S. recession probability rises
red. It is crystal clear that we are
not presently in a recession, and 100
90
nor does anything suggest that one
80
is imminent. However, a number of
Recession probability,
12-month ahead (%)
70
recession gauges are rising 60
(Exhibit 28). 50
40
30
Inflation materializes 20
Inflation is rising in the developed 10
0
world (Exhibit 29). An era of very 1960 1970 1980 1990 2000 2010 2019
low inflation, punctuated at times Note: Probabilities of a recession twelve months ahead estimated using the difference
between 10-year and 3-month Treasury yields. Shaded area represents recession.
by outright deflation, is being Source: Federal Reserve Bank of New York, Haver Analytics, RBC GAM

supplanted by a period of normal-to-

brisk price increases as the business Exhibit 29: Rising developed-world inflation
cycle advances and oil prices surge.
9
8
This inflation inflection has captured 7
the attention of financial markets, 6
CPI (YoY % change)

and arguably caused the stock 5
4
market’s initial swoon near the start 3
of 2018. Rising inflation is an issue 2
for both fixed-income and equity 1
0
investors. Bondholders demand a -1
higher yield when inflation rises, -2
2004 2006 2008 2010 2012 2014 2016 2018
forcing bond prices to equilibrate World Advanced economies EM economies
downward. Higher yields then lure Source: IMF, Haver Analytics, RBC GAM
investors from the stock market and
increase corporate borrowing costs,
Exhibit 30: Inflation barometer edging higher but still anchored
compressing equity valuations. For
these reasons, inflation scares must 1
be taken seriously: they are the one
occasion when stocks and bonds do
Debt Large Monetary
not provide a helpful counterweight Commodity
prices
Protectionism
erosion monetary policy
base risk/reward
to one another. 2
How problematic is rising inflation Inflation

Inflation Economic Clear inflation
likely to be? The short answer is expectations slack target
that it should be manageable 3

Demographics Globalization Tech deflation Sector effects
(Exhibit 30). Several macro • Comparative • Technology prices • Health care
advantage
developments are helping to push • Global Phillips
• Automation
• Industry disruption
• Education
up the price level, including the curve
Source: RBC GAM

recent spurt in oil and U.S. trade
measures. U.S. inflation could briefly
graze 3.0% – high by the standards Exhibit 31: U.S. companies are paying more to hire
of recent decades. However, any
surge is unlikely to be sustained 2.5
job switchers and job stayers (ppt)
into 2019 as other forces indicate 2.0

U.S. wage growth gap of
inflation should be closer to a tame 1.5

1.0
2.0% to 2.5%. These factors include
0.5
anchored inflation expectations and
0.0
economies operating in the vicinity of
-0.5
their potential.
-1.0
-1.5
While the relationship between a 1997 2000 2003 2006 2009 2012 2015 2018
tight economy and rising inflation is 12MMA 6MMA No smoothing
subtler than it once was, we can still Note: Wage growth gap measured as difference in year-over-year percent change of wages of job
switchers and job stayers. Source: Federal Reserve Bank of Atlanta, Haver Analytics, RBC GAM

see clear linkages. A case in point

is that companies are now willing Exhibit 32: RBC GAM CPI forecast for developed markets
to pay a premium when poaching
3.0
employees (Exhibit 31). 2.50% 2.50%
2.5 2.25% 2.25% 2.25%
There are a number of structural
CPI (YoY % change)

2.00%
2.0 1.75%
drags that argue firmly against
1.50% 1.50%
unhinged inflation. Demographic 1.5 1.25%
forces now suppress developed-
1.0
world inflation, as does globalization
and technological change. This last 0.5
force is strengthening, depressing 0.0

prices through ever-cheaper U.S. U.K. Canada Eurozone Japan
2018 2019
technology costs and automation. Source: RBC GAM
In the end, we look for rising

developed-world inflation and hold
Exhibit 33: Developed countries in monetary-tightening mode
a slightly above-consensus view, but
not to the extent that inflation is set 14
Central bank policy rate (%)
to become a problem. And some of 12

the pressure should begin to abate 10
in 2019 as the recent oil-price spike 8
falls out of the equation (Exhibit 32). 6
4
Emerging-market inflation is not
2
immune to these upward forces,
0
though ultimately seems capable 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
of remaining tame relative to Global Developed markets Emerging markets
Note: Policy rates of the U.S., Canada, U.K., Eurozone, Switzerland, Sweden, Norway, Japan,
the historical norm. A number of Australia, China, India, South Korea, Russia, Brazil and Mexico aggregated and weighted by
PPP-based GDP share. Source: Haver Analytics, RBC GAM
countries with chronically high
inflation seem to have cracked
the code for taming their excesses of England (BOE) have also moved active central banks have no
thanks to better governance. gingerly in this direction. These interest in returning policy rates to
actions have been a key contributor prior peaks.
Monetary policy marches on to rising bond yields, alongside
improved economic growth and In an environment of more
A number of developed-world central constrained growth (relative to the
higher inflation.
banks are now exiting the era of pre-crisis norm), an appropriate
extreme monetary stimulus. The U.S. Despite these moves, policy rates policy rate is simply not as high
Federal Reserve (Fed) has been the remain low by historical standards as it once was. Furthermore, high
leader, dragging the fed funds rate (Exhibit 33). This is partially because debt levels mean that every rate
off the floor while simultaneously big central banks like the European hike today packs a bigger punch
beginning the long process of Central Bank (ECB) and the Bank of than it once did. In turn, developed-
shrinking its balance sheet. The Japan (BOJ) have not yet budged, world policy makers have generally
Bank of Canada (BOC) and the Bank and partially because even the

concluded that a neutral policy rate

is now merely 2.75% or so. Exhibit 34: U.S. housing-affordability gap
While rate hikes act as a brake Affordability at

30 Poor home normal rates now
on economic growth, there are no
% deviation from fair value

affordability around average
obvious policy errors occurring. 10
Central banks are right to be -10

tightening at a time of rising Good home
-30 Affordability at
affordability
inflation, solid growth and vanishing current rates is still
-50 good
economic slack.
-70
1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018
U.S. sails along Fixed floor Fixed actual
Note: Fixed floor imposes a minimum "normal" mortgage rate in the affordability calculations, and so
The U.S. economy continues to reveals how affordability would look at normal mortgage rates. Fixed actual calculates the current carrying
move nicely, even if the first part of cost of a home versus the historical norm. Source: Haver Analytics, RBC GAM
2018 has not quite lived up to the

heroics of 2017. Growth is tentatively
reviving into the middle of the year. Exhibit 35: U.S. dollar recovered some lost ground recently
The big boost from U.S. tax cuts
remains a key support, financial 130
USD trade-weighted value (real)
conditions have not yet begun to 125

hurt, and we see evidence of a 120
higher potential U.S. growth rate. 115
110
Consumer spending is still strong
105
but set to moderate because of
100
higher oil prices. On the other
hand, businesses are eager to 95
invest. Unlike in prior periods of oil 90

1997 2000 2003 2006 2009 2012 2015 2018
strength, the U.S. petroleum sector Source: J.P. Morgan, Haver Analytics, RBC GAM
is now large and nimble enough to
buttress overall economic growth.
Exhibit 36: U.S. fed funds rate
The U.S. housing market remains Equilibrium range
a source of untapped economic 24
upside. Residential construction 22
20
remains tame relative to 18
16
demographic need, and affordability 14
is still good even after years of rising 12
%
10
home prices (Exhibit 34). 8
6
Altogether, we anticipate strong and 4
2
above-consensus GDP growth of 0
3.00% in 2018, followed by a rise of -2
1980 1985 1990 1995 2000 2005 2010 2015 2020
2.75% in 2019 – the latter dimmed Last plot: 1.70% Current range: 0.02% - 2.19% (Mid: 1.10%)
Source: Federal Reserve, RBC GAM
slightly as fiscal stimulus and

financial conditions become

less helpful. Exhibit 37: Macro conditions in Eurozone weakened
U.S. inflation is already above the 120

60
Euro area Manufacturing PMI

115
2.00% threshold, and we have
55 110
upgraded our price forecast in 105
50
(index level)
Index level
recognition that it could touch 3.00% 100
as oil prices bleed through. Inflation 45 95
should average 2.50% in 2018 and 40 90
85
then drop to 2.25% in 2019. 35
80
30 75
The U.S. dollar is not far from its 2001 2003 2005 2007 2009 2011 2013 2015 20172018
cyclical peak, but could advance a Euro area Manufacturing PMI (LHS) Euro area Economic Sentiment (RHS)
Germany ifo Business Climate (RHS)
bit further in 2018 (Exhibit 35). For
Source: European Commission, ifo Institute, Haver Analytics, RBC GAM
the Fed, we anticipate another three
to four rate hikes over the next year,
essentially in line with the market
Exhibit 38: Euro breakup risk rises, but still low
and not far from the Fed’s own dot-
plot projections (Exhibit 36). 80 Eurozone
sovereign debt
sentix Euro Breakup Index, euro
70 crisis
Eurozone complications 60 Grexit French
fears presidential
While Eurozone growth of 2.4% 50 election
area (%)
Italian populist
in 2017 was the fastest since the 40
Brexit coalition
government
financial crisis, the region has 30 vote
formed
seemingly decelerated more than 20
most in recent months (Exhibit 37). 10
The region is still growing fairly well, 0
Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 May
Jun-18
but the euro’s strength in 2017 may
Note: Index measures the percentage of investors that expect at lease one country to leave the
be having a lagged negative effect. euro area within the next 12 months. Source: sentix GmbH, Haver Analytics, RBC GAM
As a result, we forecast a slightly

below-consensus 2.25% GDP growth No discussion of continental Italy’s two populist parties have
for 2018, a bit less than in 2017. Europe would be complete without succeeded in forming a government.
Growth should slow again in 2019, an acknowledgement of the This is probably not good for the
to 1.75%. complicated political environment Italian economy and certainly hasn’t
there. Eastern Europe’s nationalist been good for Italian financial
A saving grace for the Eurozone
governments are straining the markets. The key question is
remains that it has more room to
European Union (EU), the Spanish whether it imperils the integrity
grow before overheating than the
prime minister was just ousted, of the Eurozone. While it is clear
U.S., the U.K. or Canada. In turn,
and Italy is now ruled by the first that some within the government
the Eurozone expansion could last
populist government in a major coalition would prefer that Italy
longer than the rest, or it could more
Eurozone economy. leave the Eurozone, we ultimately
significantly exceed its sustainable
think this is unlikely given public
growth rate in the meantime. Italy deserves particular attention. support for the Eurozone and
After a great deal of misdirection, constitutional limitations on exiting.

For now, surveys suggest the risk of

a Eurozone breakup has increased Exhibit 39: U.K. overshadowed by Brexit
but remains low by the standards of
4
recent years (Exhibit 38). Recession
U.K. real GDP (YoY % change)

3
2
The ECB is signaling a gradual shift 1
in policy away from the current 0
setting of stimulus delivery, but only -1
very slowly. Italy’s complications -2 Slowest
growth in
could yet delay such moves. We -3 5 years
think the euro is set to relinquish -4

-5
part of its 2017 gains.
-6
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
U.K. bad news increasingly Source: ONS, Haver Analytics, RBC GAM
priced in
The British economy remains
underwhelming by virtue of Brexit- Exhibit 40: Brexit probabilities and implications
related uncertainties and frictions. 60
The country just recorded its slowest 50%
rate of annual growth in many years 50 -5%
hit to GDP
at the same moment that other
Probability (%)
40
countries were surging (Exhibit 39). 30%
30 -8%
-2% hit to GDP
We forecast further modest growth hit to GDP
20
on the back of anemic business
8%
investment and a soft London 10 5% 5%
2%
housing market. Consumers have 0
remained fairly keen to spend, but No Brexit Soft Softish Middling Hard Chaotic
Brexit Brexit Brexit Brexit Brexit
this support comes at the expense Source: RBC GAM
of an unsustainably falling savings

rate. This economic backdrop economic drag of as much as 5% 2.50% in 2018 followed by 2.25% in
translates into GDP growth of just spread over a number of years. 2019. The Bank of England is in no
1.5% in both 2018 and 2019, in line Fortunately, 1% to 2% of this drag rush to tighten given the economic
with the consensus. has already materialized, leaving environment, but the fact that the
less economic underperformance economy is already bumping up
Brexit negotiations loom over remaining. The pound should soften against natural constraints suggests
the country, with an early-2019 further, helping to temper the pain of a smidgen of tightening over the
deadline for a deal followed by a losing unimpeded market access to next year.
transition period through the end continental Europe.
of 2020. There remain a number of
Holding out hope for Japan
possible outcomes (Exhibit 40). We British inflation spiked to above
believe a middling or softish Brexit 3.00% in 2017 on a weak pound, Japan had strung together a few
are the two most likely scenarios, but has since settled back down. years of strong GDP before slowing
translating into a cumulative We have lowered our CPI forecast to in early 2018. We continue to

anticipate decent progress from the

long-dysfunctional economy. Exhibit 41: Japan’s labour market is now very tight
Japan has unquestionably made 1.7

Tight labour
headway from a cyclical perspective. 1.6
Ratio of active job openings to

market to push
1.5 wages and
The economy is now quite tight by 1.4 inflation higher
1.3
virtually any metric, most especially 1.2
the labour market (Exhibit 41). applicants 1.1
1.0
0.9
More than for most countries, this 0.8
labour constraint is an important 0.7
0.6
development in that it raises the 0.5
0.4
prospect of Japanese inflation 0.3
continuing its gradual climb after 1988 1993 1998 2003 2008 2013 2018
Source: MHLW, Haver Analytics, RBC GAM
a decade of deflation. We believe
the country’s extreme monetary
stimulus is beginning to revive
Exhibit 42: Prices of durable goods in Japan no longer falling
inflation expectations, leading to our
above-consensus 1.25% inflation 120
forecast for 2018 followed by 1.50% 110
Japan CPI (1990=100)
for 2019. Changes are already visible 100

within Japan’s consumer price index. 90 Durable goods were the
main culprit during the
For one thing, prices for durable 80 deflationary
spiral
goods have stabilized after being the 70
60
primary source of deflation for many
50
years (Exhibit 42).
40
1990 1994 1998 2002 2006 2010 2014 2018
Structural-reform efforts may allow Headline CPI Services Durable goods Non-durable goods
Japan to grow a bit more quickly than Note: Shaded area represents Japan's deflationary spiral. Source: Ministry of Internal Affairs and
Communication, Haver Analytics, RBC GAM
the market assumes. We budget for
1.50% GDP growth in 2018 followed
by 1.25% in 2019. Japan’s labour encountered some political China claims a share of
force is luring more workers, the hot water lately but seems capable centre stage
country recently penned a pan- of surviving.
China’s economy has long been
Pacific trade deal and Tokyo could
Unlike other developed countries, a story of remarkable success,
benefit from a boost in capital
Japan is still some distance from its even more so as it now nears
expenditures in the lead-up to the
central bank having to raise rates. the U.S. in economic might and
2020 Summer Olympics. On the
Until inflation has risen further, there begins projecting its power. It is
horizon, Japan’s proposed sales-tax
simply isn’t the need even though nevertheless consciously opting to
hike in late 2019 could pull activity
the economy is strong. Instead, the downshift in the hope of relying less
forward in advance of the event,
Bank of Japan continues buying on dangerous credit-induced growth.
and then temporarily depress it
bonds (albeit at a slowing pace). We As a result, we budget for Chinese
afterward. Prime Minister Abe, the
expect the yen to strengthen slightly GDP to slow from nearly 7.00% in
architect of the country’s revival, has
given the currency’s undervaluation.

2017 to 6.50% in 2018 and then

6.25% in 2019. That puts us a little Exhibit 43: You can own a car in Beijing if you win the lottery
below the consensus.
10
As it grows wealthier, China 9
Beijing license plate lottery

8
success rate (% of total

continues to morph from a
7
manufacturing-oriented nation
applications)
6
to a consumer-led one. Other 5
countries have run into trouble 4
while navigating these shoals, and 3
none have had to do it on China’s 2
incredible scale. Reflecting the 1

0
herculean size of China’s biggest 2011 2012 2013 2014 2015 2016 2017 2018
cities and their notorious traffic, Source: Beijing Passenger Car Index Regulatory Office, RBC GAM
only one in 1963 Beijing residents
were successful in their application
Exhibit 44: Chinese home prices have decelerated, but are still rising
for a car license in the latest year
(Exhibit 43). One would think that 21
such fundamental transportation
China 100-city average new home
18
constraints would eventually 15
price (YoY % change)
impinge on economic growth, 12

though there is little evidence of 9
pain so far. 6
3
Housing, until recently a key Chinese 0
economic driver, is now moving -3
less quickly. This is a key part of -6
the country’s goal of reducing its 2012 2013 2014 2015 2016 2017 2018
reliance on credit (Exhibit 44). To Source: China Index Academy/Soufun, Haver Analytics, RBC GAM
this end, China has made significant

progress on the debt excesses that Exhibit 45: China’s four shrinking debt risks
were so worrying just a few years
ago (Exhibit 45). Declining leverage
• Credit growth no longer hugely outpacing GDP
China is vulnerable to a U.S. trade • Though absolute debt load still high
war, though the country is less Heavy industry debt
reliant on U.S. exports than many • Stronger global demand and restructuring fixes heavy industries
think (refer back to the estimates in • Heavy industries were responsible for bulk of Chinese bank bad loans
Exhibit 19). It is reasonable to expect Local government debt
trade and geopolitical fireworks • Local government debt was precarious and reliant on housing boom
between the two countries in the • But debt swap, stricter oversight and rebalancing of gov’t revenues fixes
years to come as the U.S. faces its Shadow finance
first genuine global rival in decades. • Shadow finance enabled market forces but was dangerous
• New rules improve transparency, duration mismatch, liability
Source: RBC GAM

Emerging markets settle in

Exhibit 46: Emerging markets rebound, but only partially
Among emerging markets, China,
India and Brazil may underperform
EM-6 annual real GDP growth (%)

10
market expectations, explaining our
slightly below-consensus emerging- 8
market growth forecast (see Exhibit 6

15 earlier in the report).
4
The recent increase in interest rates,
2
oil prices and the U.S. dollar are all
relatively challenging for emerging- 0
2000 2004 2008 2012 2016 2019
market economies. However, so far RBC GAM forecast
they have not shown much ill effect Note: EM-6 includes Brazil, China, India, Mexico, Russia and South Korea. Source: Haver Analytics,
RBC GAM
and it is worth keeping in mind
that they have been battle-hardened
by other economic headwinds in
recent years. Exhibit 47: Growth gap between developed and emerging markets growing
Despite our relative caution, 7

DM-EM GDP growth differential
emerging-market countries have 6
staged something of a recovery in 5
recent years after a lengthy post- 4

(ppt)
3
crisis deceleration (Exhibit 46).
2
We believe emerging markets will
1
experience their strongest growth
0
in a while in 2018 with an overall IMF
-1
5.5% GDP gain, supported by strong forecast
-2
global demand. 1970 1983 1996 2009 2022
Note: Real GDP growth differential measured as the difference between annual real GDP growth
of developed and emerging countries. Source: IMF, Haver Analytics, RBC GAM
Another point in favour of emerging
markets is their attractive valuations
– which offer a hint that developing
Exhibit 48: EM current-account surplus has shrunk a lot
economies may be earlier in the
economic cycle than developed 5.5
markets. The IMF believes that
4.5
Current account balance
emerging markets may even manage

3.5
to stretch their growth advantage
(% of GDP)
2.5
over developed nations across the
1.5
next few years (Exhibit 47).
0.5
A final thought on emerging -0.5
economies is that their much -1.5
1996 1999 2002 2005 2008 2011 2014 2017 2020 2023
discussed tendency to produce more
IMF forecast
than they spend – the so-called Note: GDP-weighted average of current account balance of 30 emerging market countries.
Source: IMF, Haver Analytics, RBC GAM
savings glut – is in retreat

(Exhibit 48). This makes sense as

China has become less competitive Exhibit 49: Global oil glut cleared
and so has a smaller current-account
surplus, while the profits of OPEC 400
OECD crude oil surplus stocks

oil producers have shrunk as shale 350
300
oil has muscled in on their space. In 250
(million barrels)
turn, downward pressure on global 200
150
interest rates becomes a bit less
100
intense. 50
0
-50
Oil in play -100
Oil prices have risen by more than -150
2006 2008 2010 2012 2014 2016 2018
40% over the past year, and are up Note: OECD commercial crude oil inventory less 5-year average of commercial stocks. Source: EIA,
RBC GAM
even more from the nadir of early
2016. This increase is largely a
function of two things.
Exhibit 50: U.S. shale boom 2.0
First, the inventory glut at the heart
10.9
of the oil shock has finally been 10.7
worked off (Exhibit 49). What is 10.5
10.3
U.S. crude production
more, insufficient investment in 10.1

(million bbl/day)
the sector during the doldrums of a 9.9

9.7
few years ago is now resulting in a 9.5
production shortfall, despite U.S. 9.3
9.1
shale-oil efforts. The supply shortfall 8.9
may get worse before it gets better, 8.7
8.5
allowing oil prices to remain elevated
8.3
or even to ascend a bit further. Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Nov-17 May-18
Source: EIA, Haver Analytics, RBC GAM
Second, geopolitical risks and drags

abound for major oil producers. Over the medium and long run, putting the U.S. on track to soon
The recent U.S. decision to re-apply however, prices may be under the surpass Saudi Arabia and Russia as
sanctions to Iran threatens to opposite pressure. U.S. shale- the biggest oil producer.
reduce the country’s oil exports oil firms are now the true swing
by up to 500,000 barrels per day producers, capable of nimbly The question, then, is what
by the end of this year and by up ramping up and scaling back constitutes fair value for these
to 700,000 barrels by the end of production fast enough to limit big U.S. oil price-setters? U.S. firms
2019. Venezuela’s economy remains swings in prices (Exhibit 50). During report that the break-even cost
in freefall and this is reducing the the 2015-2016 plunge in oil prices, necessary to motivate additional
country’s oil production. Output in the producers succeeded in quickly production sits at just US$50 per
Libya and Nigeria is also uncertain cleaving 1 million barrels from daily barrel (Exhibit 51). In turn, that’s
due to internal conflicts, though production. Since late 2016, the U.S. as good a guess as any for where
OPEC could yet boost output to sector has managed to add a hefty oil prices should gravitate over the
smooth these concerns. 2 million daily barrels of supply, medium to long run.

Canadian challenges
Exhibit 51: Profitability threshold for U.S. oil producers
Canada’s economy expanded by a
relatively strong 3.00% in 2017, and
90
Breakeven price to drill a

statistics show that growth remains
new well (US$/barrel)

80
steady so far in 2018. Higher oil 70
$52 $53 $54 $55
$47 $49 $50
prices are a welcome development 60
50
for the energy sector’s profitability, 40
but there is little evidence of any 30
response in the form of additional 20
10
capital expenditures due to the 0
high extraction cost of the country’s Permian Permian Bakken Permian SCOOP/ Other U.S. Other U.S.
(Midland) (Delaware) (other) STACK (shale) (non-shale)
reserves. Transportation constraints Average breakeven price
are also a concern, and the federal Note: Bars show the maximum and minimum breakeven prices (WTI price) in the top two areas in which the
respondent firm is active. Source: Federal Reserve Bank of Dallas Energy Survey Q1 2018, RBC GAM
government’s recent takeover
of the Trans Mountain Pipeline
project symbolizes the uncertainty Exhibit 52: Canadian competitiveness challenges
surrounding the sector.
Two familiar threats continue to Loss of Canadian competitiveness versus U.S.

loom over the Canadian economy: Taxes •• U.S. taxes fell, Canadian taxes have mostly risen (-0.25% GDP)
a competitiveness shortfall and a Tariffs •• U.S. hitting Canada with tariffs (-0.5% to -1.0% GDP)
slowing housing sector. These result
Regulations •• U.S. deregulating, Canada regulating
in our below-consensus forecast
Moral suasion •• White House threatens companies that expand outside U.S.
for just 1.75% GDP growth for the
•• Canada in Paris agreement, U.S. out
entirety of 2018 followed by 1.50%
Environment •• New carbon taxes ramp up over five years (-0.5% GDP)
growth in 2019. Both are vague in •• More extensive resource consultation process
their timing and implications, but
•• Tougher labour laws in Canada (ON, AB, BC)
indicate economic underperformance – Sharply rising minimum wage (-0.1% GDP)
Labour
over time. – Easier unionization, FT/PT equivalency
Canadian competitiveness has •• Transportation constraints: Both pipeline and rail are
problematic
taken a number of steps backwards •• Housing rules: tightening in Canada, easing in U.S.
Other?
as infrastructure projects become •• Household debt: very high in Canada, middling in U.S.
harder to deliver (Canada now •• Electricity?: Big jump in Ontario
ranks 34th out of 35 OECD nations •• Free trade: Canada signs CETA, CPTPP, interprovincial deals
for the time it takes to approve •• Immigration: More and higher quality in Canada than U.S.
On the other
a construction permit), taxes •• Public debt: Lower public debt than U.S. even with provinces
hand…
•• Interest rates: Lower in Canada (but rising in both nations)
rise, the minimum wage goes up
•• New IP strategy?
and environmental laws tighten.
Simultaneously, the U.S. has made Source: RBC GAM
efforts to become more competitive.
The resultant competitiveness wedge
is considerable (Exhibit 52).

Businesses appear to be
responding to Canada’s diminished Exhibit 53: Canadian business investment to fall again in 2018
competitiveness. Surveys anticipate
that business investment will decline 200
190
in 2018 for the fourth consecutive
Canadian private capex

180
year (Exhibit 53). Foreign direct 170
(C$ billions)
investment in Canada is also falling. 160
150
Canada’s frothy housing market 140
130
constitutes another threat, in part
120
because it now accounts for a 110
much larger portion of economic 100
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
growth than it has generally been
Note: Capital expenditures for latest 2 years are preliminary actuals and intentions.
the case in the past and because Source: Statistics Canada, Haver Analytics, RBC GAM
serious economic problems have

historically been spawned by a
Exhibit 54: Existing-home sales plunged in biggest markets
country’s housing sector. There is
also evidence that a mix of rising 10 4.5
mortgage rates and other measures 4.0
9
designed to slow the market are
Existing home sales
Existing home sales

3.5
(thousand units)
(thousand units)
beginning to have an effect. 8
3.0
7
This year marks the first time in 2.5
6
a decade that mortgage holders 2.0
with the standard 5-year term 5 1.5
are encountering a higher 5-year 4 1.0
rate upon renewal. The value of 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Toronto (LHS) Vancouver (RHS)
existing home sales across Canada Note: 12-month moving average of monthly existing home sales. Source: CREA, Haver Analytics,
RBC GAM
is down by nearly 30% since the
end of 2017, and by over 40% in
the Toronto region (Exhibit 54). Exhibit 55: The Vulnerabilities Barometer around record high
The Bank of Canada continues to
5 5
point to housing as the country’s
from the thresholds, cumulated over all
4 4
Number of standard deviations away
largest financial-system vulnerability 3 3

four sectors considered
(Exhibit 55). 2 2
1 1
Given threats to competitiveness 0 0

-1 -1
and housing plus NAFTA uncertainty,
-2 -2
there is no need for rapid rate-hiking -3 -3
in Canada, though the central bank -4 -4
1997M01
1999M01
2001M01
2003M01
2005M01
2007M01
2009M01
2011M01
2013M01
2015M01
2017M01
has hinted at a tentative summer

Corporate sector Housing market Vulnerabilities Barometer
rate increase. Banking sector Households sector
Notes: The areas below zero show the evolution of the indicators for each sector before they breach the
Canadian inflation should come in vulnerability threshold. The barometer is restricted to be positive. However, each sectoral measure is bounded
below at -1 since no individual indicator is allowed to be lower than one standard deviation away from the
at 2.25% this year and 2.00% next warning threshold. Source: Bank of Canada

year. Provincial minimum-wage hikes

Exhibit 56: U.S. 10-year bond yield
are responsible for only part of this Fair-value estimate composition
increase. The rest comes from oil
United States United States
plus a tight economy. The Canadian
CPI Inflation Real 10-year T-bond yield
dollar seems capable of shedding
12
several additional cents due mainly 16
14 10
to the competitiveness shortfall. 12 36-month Centred CPI 8
10 Last Plot: 2.3%
12-Month Forecast: 2.3% 6
8 +1 SD
Rise in bond yields stalled by 6
+ 4
%
Last Plot: 0.6%
Italy’s political turbulence
%
4 2
2
0
Global bond yields paused in the 0 -1 SD Average: 2.1%
-2 -2 12-Month Forecast: 1.02%
past quarter after having risen -4 -4
1960 1970 1980 1990 2000 2010 2020
steadily since mid-2016 on the 36-month Centred CPI Inflation Actual Monthly CPI Inflation
1960 1970 1980
Real T-Bond Yield
1990 2000 2010 2020
Real 10-Year Time Weighted Yield
back of an improving economy and Source: RBC GAM, RBC CM Source: RBC GAM, RBC CM
firming inflation. The formation of a

populist government in Italy led to U.S. 10-year T-bond yield
Equilibrium range
concerns about the banking system,
16
prompting investors to chase safe-
14
haven assets later in the quarter.
The U.S. 10-year yield backtracked 12
after briefly rising above 3% and 10
was effectively unchanged over 8

%
the three-month period ended May 6
31, 2018. In Germany and the U.K., 4

2 May '19 Range: 2.50% - 4.28% (Mid: 3.39%)
10-year government bond yields May '23 Range: 3.81% - 5.59% (Mid: 4.70%)
ended the quarter lower while in Italy 0
1980 1985 1990 1995 2000 2005 2010 2015 2020
they soared by more than 100 basis Last Plot: 2.86% Current Range: 2.11% - 3.90% (Mid: 3.01%)
points. Compared to our modelled Source: RBC GAM, RBC CM
estimates of equilibrium, yields
in Germany, the U.K. and Japan
an appropriate level for the nominal policy pounded real interest rates to
are at risk of significant upward
yield. The current yield on U.S. levels that were unsustainably low
adjustment, whereas yields in the
10-year Treasuries is close to our and investors are now starting to
U.S. and Canada are already near our
modelled estimate. That’s because demand a higher real (after-inflation)
modelled expectations (page 44).
reported inflation is currently at the return on their savings as memories
Our model for the U.S. 10-year bond modelled level and, while real rates of the crisis fade. It is difficult to
suggests an upward bias to yields of interest are historically low, they predict real interest rates with
over the long term, but also that are at appropriate levels based on certainty, but our model assumes
adjustments can be gradual and our approach which places greater they ultimately revert to their 40-year
distributed over an extended period. emphasis on recent experience. average, with the difference being
Exhibit 56 lays out the components Note, however, that the model distributed evenly, over the next five
of our fixed-income model, which forecasts a rise in real interest years. The entire increase in yields
combines an inflation premium with rates going forward. The financial forecast by the model is predicated
a real rate of interest to determine crisis and unorthodox central-bank on rising real interest rates because

we don’t anticipate much change in

Exhibit 57: Global stock-market composite
inflation over the longer term. The Equity market indexes relative to equilibrium
current modelled equilibrium level
for the U.S. 10-year yield is 3.01% 100
and moves to 4.70% in five years. 80
% above/below fair value

This shift higher is not necessarily 60
our forecast, but it’s not a bad guess 40
for where bond yields are headed. A 20
Last Plot: -13.9%
sustained rise in bond yields, even 0
if gradual, would act as a headwind -20
for sovereign-bond investments and -40
lead to low, or even negative, total
-60
returns. Our forecast for the U.S. 1980 1985 1990 1995 2000 2005 2010 2015 2020
10-year yield is 3.00% over the next Source: RBC GAM
year, with risks tilted to the upside.
Equity-market volatility Exhibit 58: Standardized S&P 500 fair-value bands

persists amid solid/improving
fundamentals
S&P 500 most
Stocks fluctuated significantly in overvalued 4
the past quarter, reacting to an +1 SD
3
abundance of headlines related to FV
2
tariffs and the possibility of a trade -1 SD
war, as well as the growing threat 1
of populism in Europe. Offsetting S&P 500 most

undervalued
many of these concerns was the still
positive macroeconomic backdrop 1960 1966 1972 1978 1984 1990 1996 2002 2008 2014 2020
and robust earnings growth. U.S., Source: Haver Analytics, RBC GAM
European and Japanese equities
were essentially flat over the offer attractive risk premiums at plots a standardized version of
three-month period ended May 31, current levels (Exhibit 57). Equities our S&P 500 fair value model. The
2018, but some indexes had more have enjoyed a long bull market. dotted line running down the centre
notable movements. Canadian While valuations are much more of the chart is fair value, and the
equities gained approximately demanding than at earlier stages of solid lines represent one standard
4% over the quarter, as rising oil the cycle, stocks are not overpriced. deviation above and below that
prices boosted energy stocks. In Europe and emerging markets, level. We have segmented the chart
Emerging markets declined roughly stocks look especially attractive into four buckets and compiled past
6% in U.S. dollars, due in part to (page 45). returns based on where the S&P
depreciation in emerging-market 500 was situated at the start of any
currencies. In aggregate, our global In the U.S., the S&P 500 Index is one-year measurement. The S&P 500
stock-market composite equilibrium trading at a slight discount to fair is currently in Bucket 2 – bounded
model continues to suggest stocks value, boding well for future stock- by fair value and one standard
market performance. Exhibit 58

deviation below. The return statistics

Exhibit 59: S&P 500 Index
in Exhibit 59 show that Bucket 2 is Return prospects by valuation zone
home to the highest batting average,
1-year
the second-highest rate of return Data 1-year average 1-year
and the lowest volatility compared set average Batting return in Max return
Valuation (Bucket) return average^ win* loss Std. dev.
with the other buckets. On average,
the S&P 500 delivers gains of (S&P 500 most overvalued) 4 (0.3%) 50.7% 14.7% (27.5%) 16.9%
12.1% in any one-year period when 1 SD Above
3 3.5% 62.3% 13.0% (41.4%) 15.6%
starting from this valuation zone and Equilibrium
produces a positive result in 84% 2 12.1% 83.9% 16.0% (44.8%) 13.5%
of months. 1 SD Below
(S&P 500 most undervalued) 1 14.7% 80.2% 19.9% (12.8%) 16.3%
Earnings growth is critical *Win = Periods where returns are above 0%. ^Batting average = Incidence of winning in any
given period. Source: RBC GAM
to sustaining U.S. equity
bull market
A deeper dive into our model Exhibit 60: Global stock-market composite
reveals that earnings will likely be Equity market indexes relative to equilibrium
the main driver of equity-market 35 May. '18 Range: 1 Std. Dev.: 14.5x - 23.1x (Mid: 18.8x)
May. '18 Range: 2 Std. Dev.: 10.2x - 27.3x (Mid: 18.8x)
returns since gains from price-to- 30 Current: 21.5x
earnings multiples have likely been
25
exhausted. Our models combine
an equilibrium P/E ratio with a 20
normalized level of earnings to 15

X
arrive at what we deem to be fair 10

value for the index. The S&P 500 P/E on Trailing 12 Months Earnings
5
price-to-earnings ratio began this +/- 1 Standard Deviation from Equilibrium P/E
+/- 2 Standard Deviations from Equilibrium P/E
bull market more than one standard 0
1960 1970 1980 1990 2000 2010 2020
deviation below equilibrium and rose Source: RBC GAM
to more than one standard deviation
above (Exhibit 60). Only during the
late 1990s have valuations been Exhibit 61: S&P 500 earnings comparison
higher, driven by speculation and
256
an insatiable demand for internet Current Reported Earnings: $125.87
technology stocks. Barring a return 128 Current Trendline Earnings: $131.35
Current Normalized Earnings: $151.27
to extreme levels of optimism and 64
risk appetite that fueled the tech 32

bubble, it would be unlikely for 16
multiples to expand much beyond 8
where they rest today. In the 4
absence of rising P/Es, earnings 2
will be critical to sustaining further 1960 1970 1980 1990 2000 2010 2020
gains in stocks. Fortunately, our Trendline Earnings Actual Earnings Normalized Earnings
normalized measure of corporate Source: RBC GAM, RBC Capital Markets

profits suggests earnings have the

Exhibit 62: S&P 500 equilibrium model
potential to increase significantly P/E factor as a function of CPI
from here (Exhibit 61). Without
25
earnings growth, though, markets
Current (CPI: 2.47%, P/E: 18.2)
are vulnerable given current
Modeled equilibrium P/E

20
demanding P/Es.
15
Not only are P/Es unlikely to expand,
but a variety of factors suggest that 10
they could come under pressure. Our Equilibrium model R-squared: 0.42
5
models compute the appropriate, or Weight in model: 31.7%
equilibrium, level of the S&P 500 P/E

0
based on its historical relationship -4 -2 0 2 4 6 8 10 12 14 16
CPI YoY % change
with six inputs. Let’s focus on three Source: RBC GAM
of these – inflation, short-term
interest rates and long-term bond
yields – which together account for Exhibit 63: S&P 500 equilibrium model
P/E factor as a function of 3-month T-Bill rate
80% of the model. Relationships
between each of these variables 25
with P/Es are plotted in exhibits 62

20
to 64, from which we can observe

that an increase in any of the three 15
leads to a lower equilibrium P/E.
Obviously then, lower yields would 10
Current (3-month T-bill: 1.89%, P/E: 20.5)
be associated with higher P/Es.
5 Equilibrium model R-squared: 0.38
Note, however, that readings below Weight in model: 29.0%
1.25% on the T-bill rate and below 0
0 2 4 6 8 10 12 14 16 18 20
3.25% on a 30-year bond yield
3-month T-bill rate (%)
correlate with a reversal in the usual Source: RBC GAM
relationship between interest rates

and valuations.
Exhibit 64: S&P 500 equilibrium model
Interest rates falling towards the zero P/E factor as a function of 30-year bond yield
bound generally coincide with some 20
sort of crisis in the economy, which 18
16
is often accompanied by a decline 14
in P/Es. What these relationships 12
also suggest is that, as economies 10 Current (30-year T-bond: 3.03%, P/E: 18.0)
move away from a crisis mode, the 8
Equilibrium model R-squared: 0.29
6
initial rise in interest rates and bond Weight in model: 21.7%
4
yields actually correlates with higher 2
P/Es. However, short-term interest 0
rates are now past the peak inflation 0 2 4 6 8 10 12 14 16 18 20
30-year T-bond yield (%)
point on the chart (about 1.25%) and
Source: RBC GAM

any further increases will likely act

Exhibit 65: S&P 500 Index
as a drag on valuations. A possible Consensus earnings estimates
inflation shock could also have a
200
meaningful negative impact on
190
Consensus earnings estimates

P/Es. Investors should keep these 180
relationships in mind because they 170
contextualize why P/Es are currently 160
high and what might cause them ($US) 150
to fall. 140
130
120
Earnings surge, propelled by
110
tax cuts 2011 2012 2013 2014 2015 2016 2017 2018 2019
2014 2015 2016 2017 2018 2019 2020
Another reason P/Es may have
Source: Thomson Reuters, Bloomberg
reached elevated levels is that
investors are pricing in a sustained
increase in corporate profits. Exhibit 66: U.S. analyst overoptimism in S&P 500 EPS estimates
Earnings have indeed been growing Monthly pattern, averages for 1985-2016
rapidly. In the first quarter, earnings
$160
grew an impressive 26% on a year-
over-year basis versus estimates of $155
18% prior to the reporting season.
President Trump’s tax cuts were $150
responsible for roughly half of
those gains, based on our analysis. $145
Moreover, revenues, which cannot

$140
be manipulated by changes in tax Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
rates, rose 8% – the fastest year- Average Forecast Error Rebased to Feb. 2018 Forecast
2018 bottom-up consensus earnings estimate
over-year increase since 2011. Part Source: Chopra, ThomsonReuters, RBC GAM
of what is driving strong earnings
growth is that profits have bounced
back from almost two years without Exhibit 67: E arnings estimates and alternative scenarios for valuations and
improvement between 2014 and outcomes for the S&P 500 Index
2016. A lack of upward progress for Consensus
those two years due to collapsing oil
2018 2018 2019 2019
prices and a surge in the U.S. dollar Top down Bottom up Top down Bottom up
pulled profits well below their long- P/E $159.6 $158.8 $175.1 $174.7
term trend (refer back to Exhibit 61).
+1 Standard Deviation 23.1 3679.5 3661.1 4036.9 4026.5
As a result, it wouldn’t be unusual
for earnings to continue to rise at +0.5 Standard Deviation 20.9 3338.8 3322.1 3663.0 3653.6
above-average rates until being Equilibrium 18.8 2998.1 2983.0 3289.2 3280.8
restored to trend. Analysts expect -0.5 Standard Deviation 16.6 2657.3 2644.0 2915.4 2907.9
the positive trend in earnings to
-1 Standard Deviation 14.5 2316.6 2305.0 2541.6 2535.0
persist and have been raising their
Source: RBC GAM

earnings forecasts in recent months,

counter to the typical pattern of Exhibit 68: Relative style performance
downgrades as a year progresses
(exhibits 65 and 66). 30%
Cumulative relative performance

25%
(indexed to 0% at start of chart)

Nov 9, 2016:
20% Trump wins
Base case scenario for stocks 15%
U.S. election
offers decent upside potential 10%

Exhibit 67 outlines several 5%
0%
combinations of consensus earnings
-5%
estimates with various P/E levels
-10%
to gauge the possibilities for the -15%
S&P 500 over the next two years. 2014 2015 2016 2017 2018 2019
S&P 500 growth / S&P 500 value S&P 600 small cap / S&P 500 large cap
Stocks could deliver double-digit Source: Bloomberg, RBC GAM
returns as long as earnings rise
as analysts expect and the market
trades at our modelled equilibrium Exhibit 69: U.S. 10-year Treasury
P/E. Multiplying the consensus of Required move in yields for break-even return against 30-day T-Bill
top-down earnings estimates for this 50
year of US$159.60 by the equilibrium 45
P/E of 18.8 – the level consistent 40
Basis points (bps)
with current and prevailing interest 35
rates, inflation and corporate 30
profitability – suggests the S&P 25

20 Last plot: 11 bps
500 would trade at 2998 by year-
end representing a 12% total return 15
from the close on May 31, 2018. 10
The same math applied to figures 5

2009 2011 2013 2015 2017 2019
for 2019 would boost that return Source: RBC CM, RBC GAM
to 25% for the coming 18 months!
It is difficult to ignore the upside over value in the past quarter strength relative to large caps,
potential offered by equities in an brought their relative gain to 25% outperforming them by 10% in
environment where a somewhat since December 2016 (Exhibit 68). the past three months. One factor
conservative view can lead to While investors initially favoured helping small-cap stocks is that
double-digit returns. value stocks immediately following intensifying protectionism
the U.S. presidential election on benefits smaller companies with
Styles: small caps and growth the prospect of increased economic a domestic focus. Small-cap
stocks lead the way activity, they ultimately gravitated outperformance may also be a sign
Growth stocks extended their gains towards stocks with a proven of increasing investor risk appetite
relative to value stocks during the ability to generate meaningful because smaller companies are
latest three-month period, and and sustained earnings growth generally more levered to changes in
small-cap stocks resumed their regardless of economic conditions. economic growth.
leadership over large-cap stocks. In terms of market capitalization,
The 3% advantage in growth stocks small caps have exhibited significant

Asset mix – maintaining

modest underweight bonds/ Exhibit 70: U.S. 10-year Treasury note and returns
overweight stocks 18
Economies are advancing in all 16
14
regions and, while growth slowed
12
a bit in the first half of the year, 10
the rate of global growth remains %
8
fairly good by post-crisis standards. 6
The business cycle is in its later 4
2
stages, but evidence of a looming Correlation: 0.96
0
recession is scarce. Risks to our 1910 1930 1950 1970 1990 2010 2030
outlook include rising interest rates, 10y UST Yields, Advanced 10Yrs
Subsequent Realized 10yr Compound Annual Nominal Returns
the ebb and flow of protectionism Source: Deutsche Bank, Haver Analytics, RBC Capital Markets
and the rising threat of populism in
Europe. Our base case, however, is
that the global economy successfully Exhibit 71: Range bound markets and cyclical bull phases
S&P 500 – 1870-2018
navigates these challenges and
continues to expand. 4096
Associated with significant economic adjustment:
2048
Fixed-income investments are 1024 1930s: depression/deleveraging
512 1970s: inflation
unlikely to deliver attractive returns 256
2000s: tech bust/housing bust/deleveraging
in an environment of moderate 128

growth, firming inflation and gradual 64
32
central-bank tightening. Rising 16
rates will act as a headwind to bond 8
4
returns and could lead to low or even 2
negative returns for bonds for many 1
1870 1890 1910 1930 1950 1970 1990 2010 2030
years. In fact, the capital loss from Source: RBC GAM, Robert J. Shiller
a mere 11-basis-point increase in
the U.S. 10-year yield would offset
any incremental return offered on Exhibit 72: S&P 500 Index
bonds relative to cash over the Long-term price momentum
year ahead (Exhibit 69). While our 9
forecasts don’t look for meaningfully 1,536
8
higher bond yields over the next 7
6
year, sovereign bonds are likely to 384
5
generate low single-digit returns
4
%
96
over the longer-term. Supporting this 3
conclusion is Exhibit 70, which plots 24 2
the yield to maturity for U.S. 10-year 1
T-bond, advanced 120 months, 6 0
1927 1942 1957 1972 1987 2002 2017 2032
against realized 10-year returns. The
S&P 500 Index (LHS) Coppock curve (RHS)
high correlation between the two Note: coppock curve based on yearly data. Source: Bloomberg, RBC CM, RBC GAM

series offers a pretty good guess

for what a 10-year T-Bond will return Exhibit 73: U.S. equity-market cycle statistics
over the next 10 years. At 2.86%
Average cycle length
as of May 31, 2018, the way ahead
for sovereign-bond investors is Secular
hardly exciting. Bull Bear
Equities offer a much more attractive 24 months

Bull 33 months
proposition for investors. In addition,
Cyclical
it seems increasingly likely that

stocks are in a secular bull market.
Stocks have historically generated Bear 11 months 23 months
significant gains over long periods
after extended phases of little-to-no
progress such as the first decade Average cycle % gain/loss
of the new millennium (Exhibit 71). Secular
Our proprietary measure of long- Bull Bear
term price momentum turned up at
the end of 2016. The last time this Bull 89% 53%
happened was in 1980, which was
Cyclical
followed by a 20-year bull market in

stocks (Exhibit 72). The notion that
Bear -18% -35%
we may be in a secular bull market
is important because rallies last 1.5
times longer and are nearly twice as
Source: RBC GAM
powerful in secular bull markets as
in secular bear markets (Exhibit 73).
Furthermore, corrections are half We have been dialing back our risk- to leave our asset mix unchanged
as severe in depth and duration in taking as the cycle has progressed. because we think the potential
secular bulls versus secular bears. Last quarter we reduced our upside in corporate profits justifies
underweight in bonds, adding one a mild overweight in stocks and
Balancing the risks and
percentage point to our fixed-income our indicators suggest a low risk of
opportunities in the short and long
position as U.S. 10-year bond recession over our forecast horizon.
term, we feel it is appropriate for
yields approached 3%. We remain For a balanced, global investor, we
a balanced investor to maintain a
underweight bonds, but less so currently recommend an asset mix
slight bias toward risk assets. While
than at previous points in the cycle of 58% equities (strategic neutral
stocks are likely to outperform over
since bonds should serve as ballast position: 55%) and 40% fixed
the longer term, it may be prudent
in a balanced portfolio if equities income (strategic neutral position:
to maintain a smaller allocation to
run into turbulence or the economy 43%), with the balance in cash.
risk assets in the shorter term given
downshifts. We opted this quarter
the maturation of the business cycle.


U.S. 10-Year T-Bond Yield Eurozone 10-Year Bond Yield
Equilibrium range Equilibrium range
16 18
14 16
12 14
10 12
10
8
%
%
8
6
6
4
4
2
2
0 0
1980 1985 1990 1995 2000 2005 2010 2015 2020 1980 1985 1990 1995 2000 2005 2010 2015 2020
Last Plot: 2.86% Current Range: 2.11% - 3.90% (Mid: 3.01%) Last Plot: 1.13% Current Range: 1.52% - 2.65% (Mid: 2.08%)
Source: RBC GAM, RBC CM Source: RBC GAM, RBC CM
Japan 10-Year Bond Yield Canada 10-Year Bond Yield

Equilibrium range Equilibrium range
14 18
12 16
10 14
12
8
10
6
%
8
%
4
6
2
4
0
2
-2
0
1980 1985 1990 1995 2000 2005 2010 2015 2020
1980 1985 1990 1995 2000 2005 2010 2015 2020
Last Plot: 0.04% Current Range: 0.39% - 1.21% (Mid: 0.80%) Last Plot: 2.24% Current Range: 1.56% - 3.10% (Mid: 2.33%)
Source: RBC GAM, RBC CM Source: RBC GAM, RBC CM
U.K. 10-Year Gilt

Equilibrium range
18
16 “Yields in Germany, the
14
12 U.K, and Japan are at risk of
10
significant upward adjustment,
%
8
6
4
whereas yields in the U.S. and
2
Canada are already near our
0
modelled expectations.”
1980 1985 1990 1995 2000 2005 2010 2015 2020
Last Plot: 1.23% Current Range: 1.40% - 3.15% (Mid: 2.27%)
Source: RBC GAM, RBC CM

GLOBAL EQUITY MARKETS

S&P 500 Equilibrium S&P/TSX Composite Equilibrium
Normalized earnings and valuations Normalized earnings and valuations
5120 May '18 Range: 2093 - 3489 (Mid: 2791) 25600 May '18 Range: 14444 - 21900 (Mid: 18172)
May '19 Range: 2179 - 3634 (Mid: 2906) May '19 Range: 14623 - 22172 (Mid: 18397)
2560 Current (31-May-18): 16062
Current (31-May-18): 2705 12800
1280
6400
640
3200
320
1600
160
80 800
40 400
1960 1970 1980 1990 2000 2010 2020 1960 1970 1980 1990 2000 2010 2020
Source: RBC GAM Source: RBC GAM
Japan Datastream Index Eurozone Datastream Index

May '18 Range: 1693 - 3835 (Mid: 2764)
1040 3200 May '19 Range: 1801 - 4080 (Mid: 2941)
Current (31-May-18): 1688
1600
520
800
260 400
200
130 May '18 Range: 289 - 880 (Mid: 584)
May '19 Range: 309 - 943 (Mid: 626) 100
65 50
1980 1985 1990 1995 2000 2005 2010 2015 2020 1980 1985 1990 1995 2000 2005 2010 2015 2020
Source: Datastream, Consensus Economics, RBC GAM Source: Datastream, Consensus Economics, RBC GAM
U.K. Datastream Index Emerging Market Datastream Index

26880 May '18 Range: 6391 - 13585 (Mid: 9988) May '18 Range: 240 - 450 (Mid: 345)
May '19 Range: 7108 - 15110 (Mid: 11109) 640 May '19 Range: 258 - 484 (Mid: 371)
13440 Current (31-May-18): 5760 Current (31-May-18): 274
6720 320
3360 160
1680
80
840
40
420
210 20
1980 1985 1990 1995 2000 2005 2010 2015 2020 1995 2000 2005 2010 2015 2020
Source: Datastream, Consensus Economics, RBC GAM Source: Datastream, RBC GAM

The bond-market outlook
of the curve should the European have been raising their estimates
Soo Boo Cheah, MBA, CFA Central Bank (ECB) deliver on rate- for productivity growth and GDP
Senior Portfolio Manager hike expectations. Meanwhile, the growth. Such revisions are not
U.S. Federal Reserve (Fed) is closer surprising because econometric
Taylor Self, MBA to the end of its hiking cycle than growth estimates tend to follow
Analyst the beginning, and further upward the direction of the economy. A
pressure on bond yields is likely to case in point is the forecast of
be modest. unemployment expectations known
as the long-run equilibrium rate of
The upward pressures on global To get some perspective, let’s look unemployment, which has fallen
bond yields appear significant. at why bond yields have risen over to less than 5% from over 10% just
Economic growth around the world the past year. A significant portion after the deep recession of 2010.
continues to be strong, inflation is of the increase has been related
picking up and labour markets are to the restoration of a meaningful Investors’ appetite for stocks and
tighter than they have been in over inflation premium to bonds – the other risky assets has been flagging
a decade. Meanwhile, the monetary compensation that investors receive in recent months after strong gains
policies of most major central banks to reflect higher expected levels in 2017 and early 2018 as central
remain remarkably accommodative. of inflation. In Europe, especially, banks withdraw liquidity and
Against this backdrop, continued the risk of deflation has receded, borrowing costs rise. Earlier this
policy tightening should not only replaced by concerns that inflation year, we said that the quicker pace
be expected, but encouraged. At will accelerate amid rising prices for of central-bank policy normalization
the same time, yields have risen to oil and other commodities. However, would make investors more
important long-term technical levels, inflation that is driven by higher discerning in assessing risk than
unsettling market participants and commodity prices is likely to be they had been in previous years. In
increasing the stridency of calls for a temporary, and we don’t expect long- particular, we highlighted that the
long-term bear market in bonds. term inflation expectations to move withdrawal of liquidity from global
meaningfully beyond most central financial markets via the end of
With the case for higher bond yields
banks’ target ranges. We believe quantitative-easing programs would
appearing so strong, it is fair to
that long-term factors such as aging be negative for risky assets. Since
wonder why we forecast that yields
populations and technological then, equity markets have wobbled,
will be practically unchanged in a
advancement will continue to mute and emerging markets, which were
year’s time. Our forecasts are based,
inflation, and therefore don’t expect judged to have among the brightest
in part, on the realization that the
inflation to accelerate to levels that prospects early this year, have
macroeconomic forces prevailing
would jeopardize financial-market suffered. As asset-price volatility
over the past year will likely shift
stability. continues to rise, the safe-haven
downwards. Moreover, we believe
status of government bonds should
that long-term structural factors Long-run expectations are important strengthen and limit the pace at
are conspiring to keep bond yields for bond holders, and have which yields can sustainably rise.
low. We also believe that central- historically provided a good estimate
bank tightening is unlikely to lead of the level of yields over time. At the core of our outlook for bond
to excessive increases in bond In the short term, however, there yields is the belief that expectations
yields. In Europe, policy tightening are indications that yields could about levels of future interest
will mostly affect the short end move higher given that economists rates are much lower than has

Global Fixed Income Markets | Soo Boo Cheah, MBA, CFA | Taylor Self, MBA
historically been the case. For some raise interest rates without hurting The question is: what happens when
time we have spoken about the economic growth. On the surface, these circuit breakers are impaired
structural reasons why such long-run this development is counterintuitive. by already high government-debt
equilibrium rates should be lower, All else being equal, economic levels and central banks limited by
including demographic changes, theory suggests that the increase in already rock-bottom interest rates?
slower productivity growth and global demand for borrowing
growing demand for safe assets. would be accompanied by an In the U.S., tax cuts have increased
Nothing suggests that these long- increase in interest rates. Our view, the U.S. government’s borrowing
term forces have meaningfully faded. however, is that higher debt levels needs over the next several years,
cannot be divorced from lower global and it has long been clear that
Lower equilibrium interest rates interest rates. the federal budget was on an
have had an important effect on unsustainable path. What the recent
the decision-making framework of Let’s analyze this connection in tax reforms have accomplished,
central bankers, as these low rates the context of current economic apart from providing fiscal stimulus
restrict the ability of policymakers to conditions. As overall debt in the to an economy requiring none, is to
respond to negative shocks. Given economy increases, two things accelerate fiscal deterioration.
that the structural factors holding happen. First, potential GDP falls,
down global interest rates are largely and lower growth expectations While the expansion of the fiscal
beyond the control of central banks, tend to result in lower real interest deficit is now providing stimulus
monetary policymakers have become rates. Moreover, any rise in interest to the U.S. economy, it has also
more cautious about tightening rates must occur very slowly to reduced the government’s ability to
policy – one area that they can facilitate continued borrowing provide fiscal stimulus tomorrow.
control. In Europe, we can see this and the rollover of existing debts, With fiscal-stimulus levers impaired,
phenomenon at the ECB, which which must be adjusted to the new, more of the burden for supporting
has maintained an exceptionally lower expectations for economic the economy in future recessions
accommodative policy stance growth. If interest rates rise too will fall to the Fed, resulting in longer
considering the strength of the quickly, borrowers will need to spells of accommodative policy.
Eurozone’s economy. Meanwhile, the devote more of their income and/ Wrapping up, global bond yields
Fed’s current hiking cycle represents or sacrifice planned investments may well rise over the next three to
the shallowest and most gradual to servicing debt and will have less six months given global economic
normalization of policy ever. left over for economy-strengthening strength and concern about inflation.
consumption. However, we then expect longer-
The final part of our argument in
favour of rates staying in check are This lesson can be extended to term structural factors to reassert
today’s historically high consumer- governments and central banks, themselves, pulling bond yields back
and government-debt levels, which which have historically taken steps down and in line with fair value.
we believe have dampened interest- to offset a slowdown in economic
rate expectations and restrained growth by boosting government
the pace at which central banks can spending and cutting interest rates.

Direction of rates
coming in the latter part of 2019, in liquidating to finance retirements.

Soo Boo Cheah, MBA, CFA our view. One risk to this outlook Economy-wide wages and prices
Senior Portfolio Manager is the growing political crisis in are also being held back by the
Italy, where some major parties are rising use of robots and government
Suzanne Gaynor vocalizing anti-EU platforms. efforts to hold down health-care
V.P. & Senior Portfolio Manager costs. Structural disinflation
RBC Global Asset Management Inc. Investor anticipation of ECB policy pressures in Japan are here to stay.
normalization should put upward
pressure on bund yields, and With bond yields rising in Europe
The U.S. Federal Reserve (Fed) the absence of additional bund and at multi-year highs in the U.S.,
raised the fed funds rate in March, purchases by the ECB should relieve we expect that the 10-year Japanese
and we expect another three to a shortage of German government government-bond yield will trade
four hikes over the next 12 months. bonds and allow yields to gravitate towards the upper end of its target
However, heightened financial- higher. Our 12-month forecast for range of 0.00% to 0.10%. We do not
market volatility relative to prior the 10-year bund yield is 0.75%, expect the BOJ to change its short-
years will keep Treasury prices which is higher than today’s level. term policy rate over the next
well supported, with bond yields Our forecast is that the short-term 12 months.
remaining near current levels unless benchmark deposit rate will not
inflation is faster than expected. move much over the next year from U.K. – We expect the Bank of
Our forecasts envisage the Fed the current level of -0.40%. England (BOE) to slow the pace at
continuing to gradually tighten policy which it tightens policy over the next
through rate hikes and the continued Japan – Inflation continues to lag 12 months. U.K. economic growth
shrinking of its balance sheet. We the Bank of Japan’s (BOJ) target of has moderated in line with global
forecast that the 10-year yield will 2% even after years of extraordinary peers and inflation pressures have
remain near 3.00% over the next 12 policy measures. More recently, eased a bit. However, in light of
months, and that the fed funds rate the BOJ dropped its prediction that steady growth and inflation above
will rise to about 2.50% from 1.68% inflation would reach 2% by the the BOE’s 2% target, it is reasonable
currently. end of next year. We believe this to believe that the central bank
shift reinforces the open-ended will continue to raise rates from
Germany – German bund yields nature of the BOJ’s commitment emergency levels. We expect the
remain below most of our estimates to generating inflation and our U.K. to be negotiating the terms and
of fair value. The European Central expectation that sustainable timeline of Brexit for a good part of
Bank’s (ECB) low policy rate and inflation isn’t coming anytime soon. our forecast horizon. Even with the
bond-purchase program have The key impediment is Japan’s aging talks’ increasing frailty, we have
kept government bond yields low population, a trend that shows no pencilled in a 25-basis-point BOE
across Europe. We expect the ECB sign of improving. There simply are rate hike, to 0.75%, premised on an
to continue progressing towards not enough young people projected extension of the global economic
eventual policy normalization to enter the workforce to offset the expansion. We are keeping the
assuming continued economic impact of retirees spending down 10-year gilt yield forecast at 1.75%.
expansion and sustainable, but not- their pensions. Japan’s disinflation
too-fast, inflation. The ECB should reflects, in part, the fact that young Canada – The Bank of Canada (BOC)
end bond purchases sometime late people do not earn enough to afford has been sidelined since January,
this year, with the first rate hike the assets that their elders are although Governor Stephen Poloz

Global Fixed Income Markets | Soo Boo Cheah, MBA, CFA | Suzanne Gaynor
has indicated that “higher interest Interest rate forecast: 12-month horizon
rates will be warranted over time.” Total Return calculation: May 29, 2018 – May 28, 2019
The BOC seems to be assessing the U.S.
effect of new mortgage rules and
Horizon
higher interest rates on the economy. 3-month 2-year 5-year 10-year 30-year return (local)
Base 2.50% 2.75% 2.95% 3.00% 3.15% 1.88%
Canadian yields have traded at
Change to prev. quarter 0.12% 0.00% 0.10% 0.00% 0.00%
historically low levels since the High 2.75% 3.20% 3.50% 3.50% 3.60% (0.71%)
financial crisis due in part to huge Low 1.63% 1.65% 1.65% 1.75% 2.00% 9.31%
demand from foreign investors. That Expected Total Return US$ hedged: 2.37%
demand seems to have hit a wall
earlier this year. Investors sold a GERMANY
net $3.1 billion of Canadian bonds Horizon

3-month 2-year 5-year 10-year 30-year return (local)
in the first quarter, compared with
Base (0.40%) (0.20%) 0.50% 0.75% 1.30% (3.27%)
an influx of $25.5 billion during
Change to prev. quarter 0.00% (0.20%) 0.00% (0.25%) (0.20%)
the same period of 2017. The bulk
High 0.00% 0.50% 1.00% 1.50% 1.90% (9.01%)
of the recent selling has been in
Low (0.40%) (0.40%) 0.05% 0.50% 1.10% (0.85%)
Government of Canada bonds,
Expected Total Return US$ hedged: (1.27%)
but demand for provincial bonds
has also faded somewhat, while JAPAN
corporate securities continued Horizon
to attract buyers. Early signs in 3-month 2-year 5-year 10-year 30-year return (local)
the second quarter show a return Base (0.10%) (0.05%) 0.02% 0.10% 0.90% (1.69%)
of foreign interest in provincial Change to prev. quarter 0.00% 0.00% 0.00% 0.00% (0.02%)
bonds. This is good news since the High 0.00% 0.10% 0.10% 0.25% 1.10% (4.30%)
Ontario government has big funding Low (0.10%) (0.10%) (0.10%) (0.10%) 0.65% 1.72%
requirements after expanding Expected Total Return US$ hedged: 0.95%
benefit promises in the run-up to a CANADA

provincial election this month. Horizon
Central-bank tightening has led to Base 1.75% 2.30% 2.40% 2.50% 2.65% (0.16%)
curve-flattening in both the U.S. Change to prev. quarter 0.00% 0.00% 0.00% 0.00% (0.05%)
and Canada, as short yields have High 2.25% 2.35% 2.70% 2.75% 3.00% (2.78%)
risen faster than longer-term yields. Low 1.00% 1.20% 1.40% 1.50% 1.70% 9.04%
We note that the yield on Canada’s Expected Total Return US$ hedged: 1.43%
30-year government bond recently
briefly fell below the yield on the U.K.
10-year security. Such an inversion Horizon

had not occurred since 2006-2007,
Base 0.75% 1.00% 1.50% 1.75% 2.05% (3.49%)
when the BOC was tightening
Change to prev. quarter 0.00% 0.00% 0.20% 0.00% (0.05%)
aggressively in the approach to the
High 1.00% 1.25% 1.60% 2.00% 2.20% (5.58%)
financial crisis. Meanwhile, the yield
Low 0.25% 0.25% 0.50% 0.75% 1.55% 4.66%
on the 30-year U.S. Treasury is about
Expected Total Return US$ hedged: (1.12%)
15 basis points higher than on the
Source: RBC GAM

Global Fixed Income Markets | Soo Boo Cheah, MBA, CFA | Suzanne Gaynor
10-year security. We do not think stays unchanged from the previous expensive, they are now fairly valued
the inversion in Canada portends quarter, with the short-term interest or even a little undervalued. For
an imminent negative shock to the rate rising to 1.75 (50 basis points markets that remain expensive,
Canadian economy. higher than current levels). We are such as Germany’s, our regional
keeping our forecast for 10-year allocation is underweight. We are
The overnight indexed swap (OIS), government bond yields at 2.50% maintaining a 5% overweight in U.S.
an indicator of where interest rates Treasuries and a 5% underweight in
are headed, is pricing in 70 basis
Regional Preferences German bunds. U.S. bond valuations
points of tightening by the first are fair to cheap, while bunds remain
quarter of 2019. We think that much Setting forecasts asides, bond yields
in most major markets are now expensive. We expect bond returns
will need to go right in the economy in most regions to underperform
to get almost three BOC hikes in close to our estimate of fair value.
Where global bonds were previously cash on a currency-hedged basis.
the next 10 months. Our forecast

CURRENCY MARKETS
Dagmara Fijalkowski, MBA, CFA Exhibit 1: USD purchasing power parity valuation
Head, Global Fixed Income & Currencies
RBC Global Asset Management Inc. 150
140
Daniel Mitchell, CFA
130
Portfolio Manager
RBC Global Asset Management Inc. 120
110
100
90
After more than a year of declines, 80
the U.S. dollar has regained its 70
footing. Since early April, the 60
73 76 79 82 85 88 91 94 97 00 03 06 09 12 15 18
dollar has risen by 5% on a trade-
USTW$: 88.03 [May 14, 2018] PPP: 82.50 [May-18] 2 standard deviations: [67.47, 97.53]
weighted basis and, in our view, Source: Bloomberg, RBC GAM
still has room to run. We have been
among the minority of investors
believing that the dollar could still Exhibit 2: Long-term cycles in the U.S. trade-weighted dollar
strengthen. Unlike in past cycles,
the dollar hasn’t reached extreme 150
8 yrs 6 yrs 10 yrs 7 yrs 9 yrs 6 yrs
levels of overvaluation (Exhibit 1). 140
-26% +67% -47% +43% -40% +42%
Without excessive valuations, the 130
120
topping process marking the end
110
of the dollar’s uptrend will likely be
100
an extended one (Exhibit 2). Our
90
12-month forecasts suggest further 80
gains will be strongest against the 70
British pound and Canadian dollar, 60
while the euro and yen should fare 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014 2018
U.S. Trade-weighted dollar
better. With these forecasts, we Source: Bloomberg, RBC GAM
remain much more bullish on the
U.S. dollar than the consensus. preference for a weaker greenback yield on the 10-year Treasury jumped
and inflationary policies such as to more than 3.0% from 2.7% in
In the 14 months ended February,
tariffs and sanctions, which should fewer than six weeks and caused the
the U.S. dollar experienced a
erode the dollar’s value over time. greenback to rally sharply over that
decline of 12%, a move that both
Also responsible were America’s period. The fact that the dollar has
helped to extend risk-taking
fiscal and current-account “twin” remained strong once yields settled
behaviour in global asset markets
deficits, which commanded more speaks to some of the other reasons
and prematurely ended the debate
attention in a year when large tax why we should expect further gains
about the dollar’s direction. As
cuts and trade protectionism were in the short term.
2017 progressed, investors became
top of mind.
more emboldened in their calls The most important of these is
for a weakening dollar. Negative It was the sudden rise in U.S. relative economic momentum,
sentiment toward the dollar was due, interest rates in April that helped which has slowed much more in
in part, to the Trump administration’s to turn the U.S. dollar around. The other major economies than in the

Currency Markets | Dagmara Fijalkowski, MBA, CFA | Daniel Mitchell, CFA
U.S. (Exhibit 3). This development

reverses the trend that had largely Exhibit 3: Relative economic momentum
driven U.S. dollar weakness last year
with an almost simultaneous dovish
Data change relative to the U.S.

400 Global data
response from central banks in outperforms
U.S. data
continental Europe, the U.K., Canada 200
and Sweden. All have backpedaled
0
on earlier plans to tighten policy
and, in turn, offered the greenback a -200
boost. Until European economic data Global data
-400 underperforms
accelerates more convincingly, the U.S. data
path of least resistance will be for -600
Sep-14 May-15 Jan-16 Sep-16 May-17 Jan-18
continued U.S. dollar strength. EZ vs. U.S. JP vs. U.S.
Source: Citibank, RBC GAM
It is also important to recognize that
the current policy backdrop remains
supportive for the greenback. Higher Exhibit 4: Cost of hedging USD nearing two-decade highs
fiscal spending offset by monetary
tightening tends to support the U.S. 3.0
dollar because such a scenario will
Weighted USD carry vs.G10 (%)
2.5
usually reflect stronger economic 2.0
growth and the higher yields that go 1.5
with it. The same can be said about 1.0
a bear-flattening of the yield curve, 0.5
where short-term interest rates are 0.0

-0.5
rising faster than the longer end of
-1.0
the curve.
-1.5
1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Also at play is positioning. Investors Source: Bloomberg, RBC GAM
speculating on the direction of the
greenback remain underweight
European political uncertainty, which that the installation of a populist
the U.S. dollar, and the cost of
would enable the dollar to rise even government in Italy will not lead
maintaining those bearish bets
in an environment where yields are to the break-up of the Eurozone –
has become prohibitive as the U.S.
falling. We acknowledge that the this type of political news causing
Federal Reserve (Fed) hikes faster
twin deficits and other longer-term only short-term volatility. We had
than other central banks (Exhibit
negative factors will burden the grown less bearish on the euro last
4). The unwinding of these bets has
greenback over time, but still believe quarter in recognition of more muted
amplified the dollar’s gains, and will
that short-term elements can drive political risks after the election
continue to do so as dollar bears are
strength in the interim. of Emmanuel Macron as French
wrong-footed.
president, faster European economic
Most recently, there are signs that Euro growth and a current-account
U.S. dollar strength may get an We are keeping our one-year euro surplus that provides steady support
additional safe-haven boost from forecast at 1.17, in line with our view to the currency. After recent euro

weakness, those forecasts imply an

expectation that the single currency Exhibit 5: EUR share of FX reserves
will be trading at current levels in
a year’s time. However, consistent 28
Share of global FX reserves (%)

with our stronger U.S. dollar view, 26
we expect that risks to our outlook
24
lie toward a weaker euro throughout
2018. We think that the euro’s 22
strength in 2017 far overshot the
20
fundamental improvement in growth,
politics and flows. A euro at 1.25 18
was not sustainable, and it appears 16

as though investors have begun to 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
Source: IMF COFER, RBC GAM
acknowledge the eventual impact
that rising oil prices, higher yields
and a stronger euro would impose
on economic activity. Exhibit 6: Unhedged yields are more attractive to Japanese investors
The impact of these negatives for 3.5%
European growth has dampened 3.0%
speculation that reserve managers 2.5%
are buying euros instead of U.S. 2.0%
dollars, a much trumpeted theme 1.5%

Yield
cited in favour of euro strength in 1.0%
recent quarters (Exhibit 5). The lack 0.5%

0.0%
of availability and overvaluation
-0.5%
of European debt don’t support 2012 2012 2013 2013 2014 2014 2015 2015 2016 2016 2017 2017 2018
increased allocations by reserve UST 10yr (hedged) UST 10yr (unhedged)
managers given that the ECB is Source: Bloomberg, RBC GAM
set to purchase almost 80% of net

Eurozone sovereign debt issuance based on three factors. The first investors. Third is the yen’s safe-
in 2018. of these is valuation. The Japanese haven qualities characterized by
yen is the most undervalued of the tendency of Japanese investors
Finally, even with the plethora of
31 important global currencies. The to repatriate capital when equity,
euro-negative developments, we
fact that the yen has been so cheap fixed-income and currency markets
note that most forecasters haven’t
acts to limit the extent to which the become more volatile.
cut their outlooks yet, a sign of
currency can decline further before
capitulation that will likely drive the The one factor that could prevent
triggering investor demand. Second,
euro lower still when it happens. the yen from strengthening is the
Japan enjoys one of the biggest
current-account surpluses in the increased cost of hedging borne
Japanese yen G10, now amounting to 4% of GDP by Japanese investors to immunize
Our view on the Japanese yen has and representing steady inflows of their portfolios from currency
evolved to a more positive one, capital from domestic exporters and fluctuations. It is likely that some

investors will choose to remove

hedges on existing U.S. Treasury Exhibit 7: Visa U.K. Consumer Sentiment Index
holdings in order to earn the much
higher yields on offer (Exhibit 6). 10
While this may limit the currency’s
gains beyond 100 per dollar, it
% change (YoY)
5
hasn’t deterred us from nudging our
forecast in the direction of further 0
yen strength toward 102 per dollar.
-5
British pound
-10
We have been taken aback by the 2006 2007 2008 2009 2010 2011 2012 2012 2013 2014 2015 2016 2017
Total Recreation & culture
resilience of the pound over the Source: Visa, Macrobond, RBC GAM
past year. The currency has fallen
8% from its mid-April peak, and,
What’s more, the cutbacks are most heavy crude trading at narrower
in our view, should trade much
pointed in discretionary segments. discounts to American blends
lower. For one thing, Britain has a
The onset of belt-tightening is one of and generally stronger global oil
weak government and Brexit-related
the reasons our economic forecasts prices. Expectations that the North
political uncertainty has worsened.
call for slower growth in the U.K. American Free Trade Agreement
What concerns us more, however,
than in other major economies. would be successfully resolved had
is the outlook for household
As this consumer-led economic also been supporting the loonie.
consumption in the U.K. For several
weakness continues, and as the However, these hopes were dealt a
years, households have relied
March 2019 Brexit deadline nears, blow at the end of May by Trump’s
on uncollateralized borrowing to
we expect the pound to weaken to decision to end the tariff exemption
maintain their spending amid slower
1.25 by this time next year. on Canadian steel.
inflation-adjusted income growth.
This trend has come at a time of Without these short-term positives,
weakness in the housing market, Canadian dollar
the Canadian dollar would almost
historically a source of wealth used The Canadian dollar has been the certainly be weaker given the longer-
to bolster spending on consumer least volatile of the major currencies, term headwinds. Rising interest rates
goods. This borrow-to-spend outperforming in the latest period and stricter mortgage rules will make
mentality limits future economic simply by moving sideways. The it more challenging for consumers to
growth, as consumers will need muted price action, we think, finance home renovations and other
to deleverage in order to raise the reflects tension between some of purchases, even as wages rise.
savings rates to more sustainable the short- and long-term drivers of
levels. Several indicators, including the currency. The Bank of Canada’s Second, economic drag will come
one prepared by Visa, suggest that insistence since last year that from businesses, as Canadian
the deleveraging we have been short-term interest rates will need companies choose to invest in
expecting has finally begun. The to rise continues to surface as an manufacturing capacity south of the
measure shows declines in credit- argument for owning the loonie. border rather than in Canada, where
card spending by consumers both Crude oil has also lent a helping regulations, business taxes and
online and in retail stores (Exhibit 7). hand of late, with prices of Canadian wages are all rising.

Exports are also a problem.

Excluding the impact of Exhibit 8: Canadian exports lagging global economic improvement
commodities, Canadian exports are
lower than we would expect given 20
57
15
improvement in manufacturing
Real non-commodity exports

10 55
indexes in the U.S. and China, 5 53
% change (YoY)
Canada’s two largest export 0 51
destinations (Exhibit 8). We attribute -5
49
the export weakness to factors -10
47
-15
such as the U.S. government’s 45
-20
efforts to stimulate demand
-25 43
for U.S. goods over imports, as 2005 2006 2007 2008 2009 2010 2011 2013 2014 2015 2016 2017 2018
well as the continued decline in Non-energy exports (LHS) China & U.S. manufacturing PMI - 5m lag (RHS)
Source: CANSIM, Bloomberg, RBC GAM
Canada’s competitiveness. The
competitiveness challenge is
evident in Canada’s current-account
balance, which has hovered around Exhibit 9: Canada basic balance of payments
a deficit of 3%-4% of GDP for almost
a decade (Exhibit 9). Coupled 10
% of GDP (4q rolling sum)
8
with the growing outflows from
6
foreign direct investment, Canada’s 4
current-account deficit represents 2
a consistent outflow of capital 0
-2
and vulnerability for the currency -4
should foreign demand for Canadian -6
bonds falter. We expect that these -8
1997 1998 2000 2001 2003 2004 2006 2008 2009 2011 2012 2014 2016 2017
longer-term themes will result in Current account Net FDI
the loonie’s decline against the U.S. Net portfolio flows Basic balance of payments
Source: Statistics Canada, RBC GAM
dollar toward our 1.35 forecast,
which lies closer to levels of
extreme undervaluation of the
Canadian dollar.

Negotiating
Sarah Riopelle, CFA
trade with Trump:
Vice President & Senior Portfolio Manager
How China will get what it wants
Chief Investment Officer
RBC Global
Trade wars Asset
haveManagement Inc. the
been all over practices without hurting American term context and within longer-
news lately. While various aspects consumers. That’s a tall order and term Chinese objectives. President
of the NAFTA negotiations have even though the new tariffs have Xi’s goal is to solidify China’s
been discussed before in the Global been suspended for now, markets ascendancy as a global superpower.
Investment Outlook, we want to have been rocked by waves of Recent policy shifts through the
put the spotlight on the China-U.S. concerns about the potentially Belt & Road initiative and the ‘Made
trade negotiations. The current negative impact on inflation and in China 2025’ plan hint at these
White House administration has interest rates. strategic aims to increase China’s
been putting pressure on China to global political and economic
reduce its trade surplus with the There were rumours a few weeks ago influence. This also includes a
U.S. That surplus is responsible for that China offered ways to reduce its special role for its currency. Plans
60% of the U.S. trade deficit, so the annual trade surplus with the U.S. to promote the use of the renminbi
attention is understandable. To that to US$200 billion from the current outside China consist of increasing
end, the U.S. imposed tariffs first on US$350 billion. The number seemed the country’s role in international
Chinese aluminum (10%) and steel ambitious, and the rumours were payment systems, international
(25%), and then announced them on denied. In this case, we are inclined reserves and international capital
a long list of other products, trying to think that where there is smoke, markets. To that end, China has
to find a way to punish Chinese trade there is fire. That’s because we view been executing incremental steps
these trade tribulations in a longer- since 2005 (Exhibit A), pushed
Exhibit A: Chinese reforms to internationalize the renminbi
2004 2006 2008 2010 2012 2014 2016 2018 2020
SHIBOR Refined Pledge to build China

Liberalizing launched monetary yield curve & welcomes
markets (2007) policy launch of govt foreign
framework bond futures expertise
(2012-2014) (2013) (2018)
SDR basket
Encouraging RMB peg CNY band RMB PBOC signs More inclusion &
RMB use dropped in widened settlement pilot swap lines 2-way FX RMB debt
favour of (2007) expanded with ECB, volatility issued by
managed float (2009) BoE (2015) Worldbank and
(2005) (2013) ALLB (2016)
Welcoming 1st Dim Sum RQFII QFII HK-Shanghai CIBM Bond Bloomberg
foreign bond issued launched launched Connect access Connect Barclays
(2007) (2011) (2012) (2014) broadened (2017) index
investment (2016) inclusion
(2018)

for inclusion in the IMF’s basket

of currencies in 2015 and, more Exhibit B: Net FX transactions by banks on behalf of clients
recently, has gradually started to
open its equity and bond markets. -100
The long-term objective is for the -50

Inflows
USD (billions)
renminbi to become truly floating,

0
but the fear is that, without
adequate preparation, opening the 50
door to capital outflows will lead to
massive currency depreciation. We 100
Outflows
need only remember what happened
150
in 2015/2016, when outflow 2010 2011 2012 2013 2014 2015 2016 2017 2018
pressure was so heavy (Exhibit B) Source: SAFE, RBC GAM
that it caused currency weakness

of 10% despite capital controls and motivation to have the renminbi’s demands. China has the power to
other government interventions to role as an international currency accommodate by substituting U.S.
prop it up. The problem lies in very enhanced. The complexity comes imports for those of other countries,
low ownership of Chinese assets from the sheer size of the inflows like Boeing for Airbus, or U.S.
by foreigners who, for example, required to offset the amount of soybeans for Brazilian soybeans.
hold less than 3% of renminbi- renminbi that would flood out of the The Chinese government has the
denominated government bonds. So country should barriers be relaxed, advantage of wielding stronger
the master plan is simply to allow and a desire to avoid excessive control than other countries, which
for greater foreign ownership of currency fluctuation. is why a true trade war is not our
renminbi assets in China to pave the base case scenario. China’s efforts
way for liberalizing outbound flows. China’s commitment to acting in to appease the U.S., at least in
Chinese nationals want to be able what its leaders see as the country’s the short term, however, would be
to invest globally, but the Chinese long-term interests suggest that negative for the currencies of U.S.
government can’t allow that without China is more likely to be patient export competitors.
offsetting inflows, so it has a strong and even accommodating to U.S.

REGIONAL OUTLOOK – U.S.
United States – Recommended sector weights

Brad Willock, CFA
V.P. & Senior Portfolio Manager RBC GAM Investment Benchmark
RBC Global Asset Management Inc. Strategy Committee S&P 500
May 2018 May 2018
Energy 6.7% 6.3%
The S&P 500 was flat in U.S. dollar Materials 3.5% 2.8%
terms during the past three months Industrials 9.0% 9.9%
as concerns regarding trade, rising Consumer Discretionary 13.5% 12.9%
inflation and interest rates, and Consumer Staples 5.7% 6.7%
increasing geopolitical turmoil Health Care 13.9% 13.9%
outweighed the positive impact of Financials 15.0% 14.2%
strong corporate earnings. Robust Information Technology 27.0% 26.0%
returns from the Energy sector plus
Telecommunication Services 1.0% 1.8%
solid results from the interest-rate-
Utilities 2.8% 2.8%
sensitive Utilities and Real Estate
Real Estate 2.0% 2.7%
sectors, as well as economically
Source: RBC GAM
sensitive Information Technology
and Consumer Discretionary sectors
were offset by negative performance S&P 500 Equilibrium
in Financials and Consumer Staples. Normalized earnings and valuations
While the global economy continues 5120 May '18 Range: 2093 - 3489 (Mid: 2791)
to expand, growth in the U.S. is May '19 Range: 2179 - 3634 (Mid: 2906)
2560 Current (31-May-18): 2705
accelerating, causing interest
1280
rates and inflation to rise and the
U.S. dollar to move higher versus 640
currencies of major trading partners. 320
The U.S. economic backdrop 160

remained solid, as real GDP growth 80
has been roughly 3% in the last
40
three quarters compared with the 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
2% trend seen since the global Source: RBC GAM
financial crisis. Growth appears

manufacturing economy is robust Bank of Atlanta, real GDP growth for
to have had decent momentum
(a level of 48 indicates a recession). the calendar-year second quarter is
heading into the last part of
In addition, internal data showed rising at a roughly 4.7% pace, while
the second quarter. Surveys of
hiring was strong and customer the New York Fed’s estimate is about
economic activity, which correlate
inventories had fallen and were lean. 3.3%. In the most recent jobs report,
well with GDP, have been coming
Importantly, the new-orders sub- the unemployment rate dropped to
in at high levels and exceeding
index jumped 2.5 points indicating 3.8%, marking a low not seen since
already high expectations. The U.S.
that activity is likely to remain high 1969. Job growth is strong, but
Manufacturing ISM rose 1.4 points to
for at least the next several months. slowing as businesses report that it
58.7 suggesting that activity in the
According to the Federal Reserve is increasingly hard to fill positions.

Regional Outlook – U.S. | Brad Willock, CFA
Wage growth is accelerating in business cycle ages. On the one structure of U.S. multinationals. We
response, mostly for young new hand, robust earnings growth makes remain cautious but note it is still
entrants in the job market and for stocks attractive. On the other hand, too early to position portfolios for a
those changing jobs, for whom macroeconomic factors such as bear market given that the earnings
wage growth exceeds 4%. According higher interest rates and inflation, cycle appears to be intact and credit
to surveys, the main problem for weigh on valuations because they markets remain supportive.
business is finding suitable workers. suggest that earnings growth is
likely to decline. In addition, rising While our base case is for stocks
The S&P 500 has risen over 12% uncertainty about the sustainability to rise modestly over the next year,
during the past year, driven primarily of the business cycle, increased there are several scenarios that
by solid corporate fundamentals and market volatility or deteriorating could lead to different outcomes.
the recent passage of legislation credit conditions will also weigh on On the downside, a policy mistake
that lowered the corporate-tax rate. valuations. We expect rising anxiety by the Fed or escalation of
After three years of essentially flat about all three of these issues to protectionist trade moves by the
earnings, the S&P 500 generated increasingly hold back valuations as Trump administration are the most
roughly 12% earnings growth in we move through the latter part of likely causes of a downturn given
2017. In the most recent quarter, the economic expansion. the potential for both to crimp the
earnings per share for the S&P 500 expansion. The market could also
climbed about 24% driven by top- The U.S. Federal Reserve (Fed) is experience a downturn if the euro-
line growth of over 8% - the best raising short-term interest rates, skeptic parties in control of Italy
in six years. Profitability remains inflation is rising, corporate- push the case for exiting the euro
exceptional as net-profit margins earnings growth is peaking, the and thereby cause a credit crisis.
were roughly 13%, near all-time market’s return on equity of 18% On the upside, if investors become
highs, and the incremental margin is near an all-time high and pretax convinced that the business cycle
on each dollar of new sales was margins are at records. We must is likely to remain intact through
19%, similar to the percentage recognize that asset prices have 2021, then earnings for 2020
of the prior five quarters. The gone up substantially over the could be roughly US$190 and the
remarkable profitability is being past nine years, and that most of market would likely trade near 3000
driven by the Information Technology the tailwinds to improved returns sometime in 2019. The key point
sector, which was the top sector are in the process of reversing. is that as long as growth remains
with incremental margins of 42%, Interest rates, which moved lower positive and the Fed raises rates at
including 73% for the semiconductor for about 35 years, appear to have a slow and measured pace, stocks
industry. bottomed in mid-2016 following should make some headway this
the Brexit vote. Labour costs as a year, but investors should continue
Although corporate financial percentage of total costs have fallen to expect returns ranging in the high
performance has been exceptional, as supply chains were made global, single digits to low double digits.
the S&P 500’s returns so far this particularly after China entered the
year have not been. While this WTO in 2001, and now a potential
dynamic may seem odd, it is quite trade war with China and others
typical of what happens as the threatens to undermine the margin

REGIONAL OUTLOOK – CANADA
Sarah Neilson, CFA Canada – Recommended sector weights

Portfolio Manager
RBC Global Asset Management Inc. RBC GAM Investment Benchmark
Strategy Committee S&P/TSX Composite
Irene Fernando, CFA May 2018 May 2018
Portfolio Manager Energy 20.0% 19.5%
Materials 12.0% 11.7%
Industrials 10.0% 10.3%
Volatility in equity markets remained Consumer Discretionary 6.0% 5.6%
elevated in the three-month period Consumer Staples 3.0% 3.4%
as investors digested the impact of Health Care 1.0% 1.3%
firming inflation expectations and Financials 34.5% 33.8%
rising bond yields on the economy, Information Technology 4.8% 4.0%
earnings outlook and valuations. Telecommunication Services 3.4% 4.4%
U.S. President Trump’s focus on Utilities 3.0% 3.5%
imposing trade restrictions stoked Real Estate 2.3% 2.8%
investor anxiety. During the period, Source: RBC GAM
higher prices for crude oil and the
solid global economic backdrop
underpinned a 5.2% total return S&P/TSX Composite Equilibrium
Normalized earnings and valuations
for the S&P TSX Composite Index,
outperforming the 0.4% gain in the
25600 May '18 Range: 14444 - 21900 (Mid: 18172)
S&P 500 Index. So far in 2018, the May '19 Range: 14623 - 22172 (Mid: 18397)
S&P TSX has been essentially flat, Current (31-May-18): 16062
while the S&P 500 has risen 2.4% 6400
and the MSCI World is up 0.8%.
The Canadian economy expanded at 1600

a 3% clip in 2017, and our forecast
is for a drop to about 1.8% this
year. Consumption is expected 400
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
to ebb in 2018 as consumers feel
Source: RBC GAM
the effects of a slowing housing
market and rising interest rates.
Continued labour-market strength cautious about hiking interest rates which is a little more than one
and minimum-wage increases could amid uncertainty regarding NAFTA multiple point lower than the S&P
act as offsets. Last month, the Bank negotiations and Trump’s recent 500. However, the gap between
of Canada (BOC) maintained the imposition of tariffs on Canadian higher U.S. multiples and Canadian
benchmark interest rate at 1.25% steel. As a result, the pace of multiples has narrowed in favour of
and slightly lowered its GDP growth interest-rate increases in Canada is Canada over the past year and we
forecasts, reflecting the housing- likely to continue lagging the U.S. think the spread should continue
market softness and faltering energy to narrow. S&P/TSX earnings
The S&P/TSX is trading just below expectations are for $1,010 in
exports. Even with inflation running
16 times 2018 EPS estimates, 2018 and about $1,140 in 2019,
at close to 2%, the BOC remains

Regional Outlook – Canada | Sarah Neilson, CFA | Irene Fernando, CFA
representing annual increases of which should translate into rising net crude oil has increased as India and
13% in each of the next two years. interest margins. China boost consumption. Supply
The earnings outlook has been remains balanced, with limited
upgraded to reflect higher crude- High Canadian consumer leverage, OPEC production allowing increased
oil prices, underpinning Energy supported by low 5-year mortgage U.S. shale output to be absorbed.
sector earnings, as well as earnings rates and falling unemployment, Going forward, OPEC’s production
momentum in the Financials sector. remains a concern for domestically strategy will be a key determinant of
The global economic backdrop exposed banks such as CIBC. In the direction of oil prices. Canadian
supports continued momentum the wake of stricter mortgage- energy producers continue to deal
in commodity prices as the global underwriting guidelines enacted with local price discounts due to
economy appears to be entering the in January, Canadian house prices the lack of distribution pathways
later part of the cycle. are up 6.6% on a year-over-year for both crude oil and natural gas.
basis but 2% below their 2017 A number of proposed crude-oil
Interest-rate-sensitive sectors such peak. Mortgage rates are up 70 pipelines are stalled due either
as Telecommunication Services basis points year over year, and will to lengthy regulatory processes
and Utilities have underperformed affect the relatively large number or public opposition. Canadian
this year amid higher bond yields. of renewals this year. Banks are producers will find it hard to secure
Tax reform in the U.S. has also reporting a slowdown in residential space on existing pipelines, forcing
contributed to volatility, with loan growth, partially offset by them to ship oil by the more costly
Enbridge in the Utilities sector being commercial lending. The result is train option. Rail transportation itself
forced to wind up master limited aggregate loan growth of 6%. currently has capacity constraints,
partnerships based south of the but we expect that these will be
border. The Information Technology Life-insurance companies are also
poised for strong profit growth in overcome in the latter half of the
sector is benefiting from a strong year. As a result, the discounted
appetite for takeovers and industry 2018, given higher long-term interest
rates and stable equity markets. price at which Canadian oil sells
growth. should improve.
New capital standards were imposed
Canadian bank stocks fell 0.7% by Canadian regulators on life Also impacted by the stalled
during the three-month period and insurers in the first quarter of 2018. pipeline environment are the major
are down 2.3% so far in 2018. The Valuations remain attractive at 10.5 energy-infrastructure companies,
latest quarterly results showed times projected 2018 earnings, TransCanada and Enbridge. The
strong operational performance, which is one multiple point lower shares of both companies have been
with earnings growth up 12% year than where the group traded one under pressure given a combination
over year. Investors expect bank year ago. of higher leverage, sizeable funding
earnings per share to grow 10% in requirements, regulatory uncertainty
2018 and 6% in 2019, based on The Energy sector was the top
performer over the past three regarding future projects and
consensus estimates. Valuations rising rates. Both companies have
have contracted to 11 times 2018 months given the rise in the North
American benchmark oil price to significant project backlogs, and the
earnings from the recent peak ability to make progress on these
of more than 12, and banks now over US$65 per barrel from less
than US$50 a year ago. In Canadian- projects without relying on debt
trade at slightly below the post- financing will be key.
crisis average. The banks’ earnings dollar terms, producers are receiving
trajectory has benefited from the $75 per barrel for their light oil
BOC’s more hawkish rate outlook, barrels today. Global demand for

REGIONAL OUTLOOK – EUROPE
David Lambert Europe – Recommended sector weights

Senior Portfolio Manager
RBC Global Asset Management (UK) Limited RBC GAM Investment Benchmark
Strategy Committee MSCI Europe
May 2018 May 2018
Energy 7.8% 8.3%
Given the political backdrop in Materials 9.0% 8.7%
Europe over the past few years, our Industrials 13.0% 13.2%
commentary on European markets
Consumer Discretionary 12.0% 11.0%
has consistently tried to address
Consumer Staples 13.0% 13.2%
the risk of political upheaval at the
Health Care 12.0% 12.2%
macro level, while trying to stay
Financials 19.1% 19.5%
focused on what is really happening
Information Technology 7.4% 5.4%
in the economy and within the
companies that populate it. Telecommunication Services 3.0% 3.4%
Utilities 2.8% 3.6%
Along those lines, we thought that a Real Estate 1.0% 1.5%
new government in Germany would Source: RBC GAM
still the political noise in Europe.
However, Italy has become the first
major European country in recent Eurozone Datastream Index Equilibrium
history to experiment with a populist
government after far-left and far- May '18 Range: 1693 - 3835 (Mid: 2764)
May '19 Range: 1801 - 4080 (Mid: 2941)
right parties cobbled together a 3200
coalition earlier this month. The 1600
coalition eliminated the need for new
800
elections but raised the possibility
that dissatisfaction with the euro 400
will become a bigger political issue. 200

We also are in the midst of Brexit
100
negotiations. Progress has certainly
been made, but the one big hurdle 50
1980 1985 1990 1995 2000 2005 2010 2015 2020
is whether a trade-hindering, Source: Datastream, Consensus Economics, RBC GAM
politically sensitive border will be
drawn between Ireland and Northern • Europe’s earnings base remains discounted versus the bond
Ireland, which is part of the U.K. In depressed relative to other major market
the next few weeks, we should get markets, and we see significant
more clarity on this matter, but the However, a few negatives have
medium-term upside potential
uncertainty does pose a risk. caught our eye:
• Credit conditions are supportive,
Focusing on business fundamentals, with real interest rates remaining • The euro has been robust,
we still see a relatively robust low particularly leading up to
backdrop, but acknowledge that the Italian election. This is a
• Relative valuations in Europe headwind for exporters, but has
there are some potential flags worth versus other equity regions become less so since the election
monitoring. On the positive side: sit at a discount, and are also

Regional Outlook – Europe | David Lambert
• Although purchasing managers’ companies have kept pace with the IFO measure of German business
indexes (PMIs) remain strong, U.S. market since the 2009 trough. confidence) moving down from high
they are turning downwards. This Ultimately, we still see the potential levels, while remaining positive. This
can signal a market shift toward for European profits to progress movement normally signals a shift
defensive stocks further as the domestic/commodity- to the slowdown phase, where large-
• Plans by the European Central exposed areas rebound. cap stocks and those considered
Bank and the Bank of England high quality and low risk tend to
From a valuation perspective, outperform small caps. Since 1995,
to tighten monetary policy
market P/Es are close to fair value, stocks have spent an average of 10
could have a negative impact
and dividend yields in all markets months in the slowdown phase, and
on equities given elevated P/E
look attractive relative to yields on have proceeded to a recession phase
multiples
bonds. On the basis of price-to-book seven of nine times. The last time
The indicator measuring Eurozone value, Europe appears cheap versus that a slowdown didn’t transition
economic surprises has declined the broad market and, in particular to recession was in 2010, when a
over the first part of 2018, and we the U.S., against which Europe rests second round of quantitative easing
have also seen leading indicators near a 40-year low. reignited the stock market with a
begin to move downwards from rush of liquidity.
At the market level, we see data that
very high levels. The rolling-over of
generally supports further earnings From a sector perspective, the
leading indicators is not necessarily
growth in Europe. Moreover, the principal changes to our sector
bearish for the market as a whole,
beginning of a decline in leading positioning have been an increase
but can have implications for
indicators reminds us that the in exposure to Financials given
sector rotation.
market can continue to advance at reasonable valuations, generally
PMIs at their current high levels are times when sector rotation would better capital positions and the
still consistent with double-digit suggest otherwise. For instance, potential uplift to banks’ profit
earnings growth and we are not we have seen a very strong run in margins and earnings from a
seeing elevated expectations for cyclical sectors over the past 24 rising-rate environment. We still
earnings. This profit trend gives us months. The strength has been remain underweight banks, with a
comfort as it indicates that there is such that, on a price-to-book basis, preference in the Financials
not too much exuberance built into cyclical stocks are trading more than sector for diversified financial
bottom-up forecasts. one standard deviation above the companies and Insurance. The
long-term average versus defensive increase in exposure to the
Eurozone earnings are still issues, and are at levels where we Financials sector has come at the
depressed at 19% below their 2008 historically have seen a reversal. expense of the Industrials sector,
highs, whereas in the U.S. they We would expect this reversal which is home to many companies
are 54% above where they were a pattern to continue over the next six dependent on a relatively fast pace
decade ago. Drilling down, however, to 12 months. of economic growth.
we see that Eurozone earnings
have been polarized between This scenario fits with the ‘style-
globally exposed companies and cycle’ work that we have monitored
those reliant on commodity prices for a number of years. Here we
or domestic revenues. In fact, are seeing the composite leading
earnings at the Eurozone’s global indicator (similar to PMIs and the

REGIONAL OUTLOOK – ASIA
Derek Au Asia – Recommended sector weights

Research Analyst RBC GAM Investment Benchmark
RBC Investment Management (Asia) Limited Strategy Committee MSCI Pacific
May 2018 May 2018
Energy 3.3% 3.3%
Asian equities, in line with global Materials 7.5% 6.7%
stocks, sold off for much of March Industrials 11.5% 12.2%
and April. However, they had pared
Consumer Discretionary 13.5% 12.5%
most of the losses by the end of
Consumer Staples 6.0% 6.5%
May, as investor sentiment improved
Health Care 5.4% 5.4%
on hopes for advancement in the
Financials 21.0% 20.5%
U.S.-China trade dispute and a
better-than-expected earnings Information Technology 22.3% 21.2%
outlook for the region’s Information Telecommunication Services 3.0% 3.9%
Technology and Health Care sectors. Utilities 2.0% 2.5%
Asian equity markets excluding Real Estate 4.5% 5.3%
Japan have been a major beneficiary Source: RBC GAM
of global economic growth over the
past year. Japan Datastream Index Equilibrium
Japanese equities were something of
a mixed bag during the three-month
1040
period amid trade threats from U.S.
President Donald Trump, domestic
520
political concerns and a softening
yen. Japanese bourses were roughly
260
flat from March to May as the yen
fell 2 percent during the period after
130 May ‘18 Range: 289 - 880 (Mid: 584)
strengthening more than 5 percent in May '19 Range: 309 - 943 (Mid: 626)
January and February. Current (31-May-18): 546
65
1980 1985 1990 1995 2000 2005 2010 2015 2020
Apart from Japan, the strongest- Source: Datastream, Consensus Economics, RBC GAM
performing markets in Asia
were South Korea and Taiwan, prices, however, will be largely level, the Bank of Japan (BOJ) left
while Thailand and Indonesia negative for Asia, with India and the its assessment unchanged that the
underperformed. Discussions aimed Philippines most affected. economy is gradually recovering,
at facilitating peace talks among signalling that growth will rebound
South Korea, North Korea and the
Japan from a slowdown in the first
U.S. have helped ease geopolitical quarter. Business investments and
tensions and boosted investor The benchmark Nikkei 225 Stock
Index has been flat since the start private consumption remain solid,
optimism about South Korean but a contraction in government
conglomerates and the country’s of 2018, following a 20% gain in
2017 that was due in part to a expenditures could lead to slower
construction industry. Rising oil growth in 2018. Consumer prices
softening in the yen. At the macro

Regional Outlook – Asia | Derek Au
have been stubbornly slow to fears of a global trade war. At the cycles, rising interest rates and
recover as inflation tracks well below sector level, Health Care and Utilities financial-market volatility.
the BOJ’s 2% target. outperformed, while Financials
and Consumer Discretionary In Indonesia, the central bank raised
The risks to our view on Japanese underperformed. By country, its benchmark interest rate by 25
equity markets are a weakening Australia and Taiwan outperformed, basis points on May 17 to 4.5% and
of the U.S. dollar versus the yen while the Philippines and Indonesia is expected to raise it by another 25
because of the Japanese currency’s lagged the benchmark. points in early June to support the
reputation as an investor safe haven, Indonesian rupiah. The Philippines’s
and Prime Minister Abe’s diminishing South Korea’s benchmark equity central bank has cut its bank-reserve
approval rating. Externally, Trump’s bourse, the Kospi, rallied and was requirement ratio to 18% from 19%,
plan to impose trade tariffs could one of the best performers in the effective June 1, to inject liquidity
become a stronger headwind for region after optimism increased into the financial system.
the U.S. dollar and would have about the possibility of peace talks
a negative impact on Japanese between North Korean leader Kim President Trump has started to
corporate earnings. It is fair to say Jong Un and the South Korean deliver on his protectionist threats
that the threat of a trade war has administration. and continues to up the ante
captured investors’ concern. against China. Trump’s view is
Australia’s economy has shown benefiting from the fact that the
Meanwhile, Abe’s approval ratings gradual progress, driven by U.S. trade deficit with China has
are weighed down by allegations increased public infrastructure increased over his presidency to
of cronyism and he now faces a spending and solid commodity its highest ever - US$386 billion
backlash over dealings with a prices. Consumer demand remains at the end of February 2018. U.S.
conservative school in acquiring respectable with solid retail-sales protectionism clearly has global
public land at a steep discount. figures, but consumers remain and regional ramifications in Asia.
Abe’s sagging political support constrained by high debt levels and Chinese President Xi Jinping appears
could dash his hopes of winning a relatively low wage growth. Savings to have opened the door to trade
third three-year term as leader of rates in Australia have declined over negotiations with the U.S., and China
the governing Liberal Democratic the past six months, but the federal has reinforced its desire to further
Party in a September party ballot. budget in May provided some open up its economy and become
A victory would put him on track support via a modest personal-tax more involved in global cooperation.
to become Japan’s longest-serving cut. Elsewhere, a sustained rally in
premier. One political tailwind for oil prices should provide a tailwind
the prime minister is the success for the broader economy.
of Abenomics: the financial
and economic reforms that he Economic growth has held up
spearheaded have been a policy in Singapore due mainly to an
boon for Japan and its economy. improvement in manufacturing
output at the start of the year, and
with growth in services exceeding
Asia Pacific ex-Japan
market expectations. Singapore and
Asia-Pacific markets edged lower Hong Kong are more exposed than
during the three-month period on the rest of Asia to global economic

REGIONAL OUTLOOK – EMERGING MARKETS
Philippe Langham Emerging Market Datastream Index Equilibrium

Head & Senior Portfolio Manager
Emerging Market Equities
RBC Global Asset Management (UK) Limited May '18 Range: 240 - 450 (Mid: 345)
640 May '19 Range: 258 - 484 (Mid: 371)
320
The case for emerging markets to
continue outperforming is largely 160
predicated on the view that these
markets are relatively early in their 80
growth cycle. The MSCI Emerging 40

Markets Index returned 38% in
2017 and 12% in 2016, making it 20
1995 2000 2005 2010 2015 2020
the best performing major global Source: Datastream, RBC GAM
benchmark by some margin over this
period. However, there was severe
underperformance between 2010 Our view that we are midway One area of concern, given our
and 2015, creating the potential through a multiyear upturn in view that emerging markets are
for further catch-up in the years emerging markets remains intact, relatively early in the cycle, is how
ahead. The gap in economic growth but it is also worth considering any we can expect emerging-market
favouring emerging markets over developments that could disrupt this equities to perform in the event of
developed markets, so instrumental thesis. The most significant threats a downturn in developed markets.
in driving equity returns over the in our view are trade; a correction The first quarter of 2018 was
past few decades, continues to in developed equity markets; a unusual in that it was one of seven
accelerate. stronger U.S. dollar; a sell-off in the quarters since 1995 during which
Information Technology sector; and U.S. equities fell and emerging
Emerging-market profit margins disappointing earnings. markets outperformed. Over that
are coming back from the 2016 period, the U.S. market had 27 down
cyclical trough, supporting a We are least concerned, at least in quarters. Similarly, if we look back at
recovery in returns on equity and the short term, by the one that has periods where the MSCI World Index
future earnings growth. Even with perhaps made the most noise so has been down over the past two
the equity recovery in emerging far this year: trade. The good news decades, emerging markets have
markets, the benchmark is trading is that signs point to Trump moving generally underperformed.
at mid-cycle valuations, with the away from a widely targeted trade
price-to-book ratio at its long-term war to a narrower and more justified Another significant potential
average of 1.8 times and a 25% dispute versus China’s business headwind for emerging markets is
discount to developed markets. The practices. The dispute appears to a stronger U.S. dollar. Historically,
emerging-market discount relative be shifting from a focus on trade the dollar and emerging markets
to developed markets, and the U.S. and tariffs towards an emphasis on have moved in opposite directions.
specifically, is significantly wider technology-related investment. This In 2017, the trade-weighted dollar
when the cyclically adjusted Shiller is likely to be a drawn-out battle, but weakened 11%, and the softening
P/E ratio is applied over the past one where the implications are very continued into the first quarter
10 years. much long term.

Regional Outlook – Emerging Markets | Philippe Langham
of this year. However, this trend than 40% of the emerging-market term weakness linked to these
reversed recently. While a stronger benchmark’s gains. The Information concerns could offer opportunities
U.S. dollar would represent a Technology sector now accounts for for rebuilding positions to take
headwind for emerging-market 29% of the index weight, up from advantage of the sector’s long-term
equities, our view is that any U.S. 10% 10 years ago. structural growth.
dollar strength would be more likely
to occur versus developed-market Following last year’s stellar After a period of acceleration, we are
currencies, as was the case in 2016, performance, Information seeing a moderation in emerging-
than against emerging markets. Technology has been market growth surprises, and it
underperforming so far this year, is a similar story with earnings
There are three key reasons for this and our stance on the sector is expectations, which have begun to
currency view. First, real interest to be underweight for a number moderate after last year’s consistent
rates in emerging markets are much of reasons. First, earnings upgrades. Current expectations are
higher than they are in developed momentum has started to decline for 14% EPS growth in 2018 and 11%
markets. Second, emerging-market sharply. Second, valuations in the in 2019. We believe these numbers
currencies look undervalued on a Information Technology sector, are reasonable given our view that
range of measures following the while not extreme, have become emerging-market profit margins will
weakness between 2010 and 2015. somewhat extended. continue to expand from a low base,
Third, economic fundamentals in the although we feel that the low end
vast majority of emerging markets We also believe that too many of a 10% to 15% EPS growth range
have improved, with Turkey being investors are chasing performance is more realistic. Earnings growth
the only significant one to have a in the Information Technology could be put at risk if we were to see
current-account deficit greater than sector and that the sector’s any change in the emerging-market
3% of GDP. current popularity limits gains reform agenda spurring productivity
going forward. Finally, the internet improvements such as, for example,
One factor that has become very stocks that have been leading the backtracking on supply-side reform
relevant for the performance of sector face risks from regulation, in China.
emerging markets is the Information government interference and lower
Technology sector’s large weighting returns from new investments. As
in the index. Last year’s gains at the earnings in the sector moderate,
index level were driven primarily we would expect a much more even
by stocks in this sector, with five distribution in earnings growth by
large-cap stocks accounting for more sector to unfold in 2018. Any short-

RBC GAM INVESTMENT STRATEGY COMMITTEE
Members

Chief Investment Officer
RBC Global Asset Management
Chair, RBC GAM Investment Strategy Committee
Dan Chornous is Chief Investment Officer of RBC Global Asset Management Inc., which has total assets under management of approximately $425 billion.
Mr. Chornous is responsible for the overall direction of investment policy and fund management. In addition, he chairs the RBC Investment Strategy Committee,
the group responsible for global asset-mix recommendations and global-fixed income and equity portfolio construction for use in RBC Wealth Management’s key
client groups including retail mutual funds, International Wealth Management, RBC Dominion Securities Inc. and RBC Phillips, Hager & North Investment Counsel
Inc. He also serves on the Board of Directors of the Canadian Coalition for Good Governance and is Chair of its Public Policy Committee. Prior to joining RBC Asset
Management in November 2002, Mr. Chornous was Managing Director, Capital Markets Research and Chief Investment Strategist at RBC Capital Markets. In that
role, he was responsible for developing the firm’s outlook for global and domestic economies and capital markets as well as managing the firm’s global economics,
technical and quantitative research teams.
Stephen Burke, PhD, CFA Dagmara Fijalkowski, MBA, CFA

Vice President and Portfolio Manager Head, Global Fixed Income & Currencies
RBC Global Asset Management RBC Global Asset Management
Stephen is a fixed-income portfolio manager and Head of the Quantitative As Head of Global Fixed Income and Currencies at RBC Global Asset
Research Group, the internal team that develops quantitative research Management, Dagmara leads investment teams in Toronto, London and
solutions for investment decision-making throughout the firm. He is also Minneapolis in charge of almost $100 billion in fixed income assets. In
a member of the PH&N IM Asset Mix Committee. Stephen joined Phillips, her duties as a portfolio manager, Dagmara heads management of several
Hager & North Investment Management in 2002. The first six years of his bond funds, manages foreign-exchange hedging and active currency
career were spent at an investment-counselling firm where he quickly rose to overlay programs across a number of funds. Dagmara chairs the Fixed
become a partner and fixed-income portfolio manager. He then took two years Income Strategy Committee. She is also a member of the Investment Policy
away from the industry to begin his Ph.D. in Finance and completed it over Committee, which determines asset mix for balanced and multi-strategy
another three years while serving as a fixed-income portfolio manager for a products, and the RBC Investment Strategy Committee. In 2016, she was
mutual-fund company. Stephen became a CFA charterholder in 1994. appointed to the RBC GAM Executive Committee. Dagmara, who began her
investment career in 1994, holds an MBA from the Richard Ivey School of
Business in Canada and a Master’s degree in economics from the University
of Lodz in Poland. Dagmara has been a CFA charterholder since 1997.
Stuart Kedwell, CFA

Senior Vice President and Eric Lascelles
Senior Portfolio Manager Chief Economist
Stu co-leads the North American Equity team and is a member of the RBC Eric is the Chief Economist for RBC Global Asset Management Inc. (RBC GAM)
GAM Investment Strategy Committee, which is responsible for establishing and is responsible for maintaining the firm’s global economic forecast and
the firm-wide global asset mix for mutual funds and for institutional and high generating macroeconomic research. He is also a member of the
net worth private clients. Stu began his career in 1996 with RBC Dominion RBC GAM Investment Strategy Committee, the group responsible for the firm’s
Securities in the firm’s Generalist program, a two-year internship in which global asset-mix recommendations. Eric is a frequent media commentator
participants rotate through different areas of the firm. In 1998, he joined the and makes regular presentations both within and outside RBC GAM. Prior
RBC Investments Portfolio Advisory Group, which provides investment ideas to joining RBC GAM in early 2011, Eric spent six years at a large Canadian
and recommendations to RBC DS Investment Advisors. He was also a member securities firm, the last four as the Chief Economics and Rates Strategist. His
of the RBC DS strategy & focus list committees. Stu has been with the firm previous experience includes positions as economist at a large Canadian
since 2002 and is a CFA charterholder. bank and research economist for a federal government agency.

Martin Paleczny, CFA

Hanif Mamdani Vice President and
Head of Alternative Investments Senior Portfolio Manager
Hanif Mamdani is Head of both Corporate Bond Investments and Alternative Martin Paleczny, who has been in the investment industry since 1994, began
Investments. He is responsible for the portfolio strategy and trading execution his career at Royal Bank Investment Management, where he developed an
of all investment-grade and high-yield corporate bonds. Hanif is Lead Manager expertise in derivatives management and created a policy and process for the
of the PH&N High Yield Bond and Alternative strategies, including a multi- products. He also specializes in technical analysis and uses this background
strategy hedge fund. He is also a member of the Asset Mix Committee. to implement derivatives and hedging strategies for equity, fixed-income,
Prior to joining the firm in 1998, he spent 10 years in New York with two global currency and commodity-related funds. Since becoming a portfolio manager,
investment banks working in a variety of roles in Corporate Finance, Capital Martin has focused on global allocation strategies for the full range of assets,
Markets and Proprietary Trading. Hanif holds a master's degree from Harvard with an emphasis on using futures, forwards and options. He serves as
University and a bachelor's degree from the California Institute of Technology. advisor for technical analysis to the RBC GAM Investment Strategy Committee.
Sarah Riopelle, CFA

Vice President and William E. (Bill) Tilford
Senior Portfolio Manager Head, Quantitative Investments
Since 2009, Sarah has managed the entire suite of RBC Portfolio Solutions. Bill is Head, Quantitative Investments, at RBC Global Asset Management and
Sarah is a member of the RBC GAM Investment Strategy Committee, which sets is responsible for expanding the firm’s quantitative-investment capabilities.
global strategy for the firm, and the RBC GAM Investment Policy Committee, Prior to joining RBC GAM in 2011, Bill was Vice President and Head of
which is responsible for the investment strategy and tactical asset allocation Global Corporate Securities at a federal Crown corporation and a member of
for RBC Funds’ balanced products and portfolio solutions. In addition to her its investment committee. His responsibilities included security-selection
fund management role, she works closely with the firm’s Chief Investment programs in global equities and corporate debt that integrated fundamental
Officer on a variety of projects, as well as co-manages the Global Equity and quantitative disciplines, as well as management of one of the world’s
Analyst team. largest market neutral/overlay portfolios. Previously, Bill spent 12 years with
a large Canadian asset manager, where he was the partner who helped build
a quantitative-investment team that ran core, style-tilted and alternative
Canadian / U.S. funds. Bill has been in the investment industry since 1986.
Brad Willock, CFA

Milos Vukovic, CFA Vice President and
Vice President, Investment Policy Senior Portfolio Manager
Milos, who joined RBC in 2003, oversees investment-management activities Brad Willock joined RBC Global Asset Management in July 2002 and is a
including new-fund launches, performance analytics and trade-cost analysis. Senior Portfolio Manager and CFA charterholder. In his current role, Brad has
He is also responsible for developing and monitoring investment mandates responsibility for RBC Global Asset Management’s core and income-oriented
and implementing tactical asset allocation for the RBC GAM investment U.S. equity strategies. He joined RBC in May 1996 after receiving a bachelor’s
solutions. Milos earlier worked for a Big 4 accounting firm and two top-tier of commerce degree with distinction from the University of Calgary. Prior to
securities firms. He earned an MBA at the Schulich School of Business and that, Brad obtained a bachelor’s of science degree at the University of British
has held the CFA designation since 2004. He is a board member of both the Columbia and represented Canada at the 1992 Barcelona Summer Olympics
Canadian Buy-Side Investment Management Association and the Canadian in volleyball.
Advocacy Council for Canadian CFA Institute Societies, and recently joined
IIROC’s Market Structure Advisory Committee.

GLOBAL EQUITY ADVISORY COMMITTEE
>> Philippe Langham >> Mayur Nallamala >> Dominic Wallington

Head & Senior Portfolio Manager, Head & Senior V.P., Asian Equities Head, European Equities &
Emerging Market Equities RBC Investment Management (Asia) Senior Portfolio Manager,
RBC Global Asset Management (UK) Limited RBC Global Asset Management (UK)
Limited Limited
>> Martin Paleczny, CFA
>> Brad Willock, CFA V.P. & Senior Portfolio Manager,
V.P. & Senior Portfolio Manager, Asset Allocation & Derivatives
North American Equities RBC Global Asset Management Inc.
GLOBAL FIXED INCOME & CURRENCIES ADVISORY COMMITTEE
>> Dagmara Fijalkowski, MBA, CFA >> Suzanne Gaynor >> Eric Lascelles
Head, Global Fixed Income & Currencies V.P. & Senior Portfolio Manager, Global Chief Economist
RBC Global Asset Management Inc. Fixed Income & Currencies RBC Global Asset Management Inc.
>> Soo Boo Cheah, MBA, CFA
Senior Portfolio Manager,
Global Fixed Income & Currencies
RBC Global Asset Management (UK)
Limited

DISCLOSURE
This report has been provided by RBC Global Asset Management (RBC GAM) for informational purposes only and may not be
reproduced, distributed or published without the written consent of RBC Global Asset Management Inc. (RBC GAM Inc.). In
Canada, this report is provided by RBC GAM Inc. (including Phillips, Hager & North Investment Management). In the United
States, this report is provided by RBC Global Asset Management (U.S.) Inc., a federally registered investment adviser. In
Europe, this report is provided by RBC Global Asset Management (UK) Limited, which is authorised and regulated by the UK
Financial Conduct Authority. In Asia, this document is provided by RBC Investment Management (Asia) Limited, to professional,
institutional investors and wholesale clients only and not to the retail public. RBC Investment Management (Asia) Limited is
registered with the Securities and Futures Commission (SFC) in Hong Kong.
RBC GAM is the asset management division of Royal Bank of Canada (RBC) which includes RBC GAM Inc., RBC Global Asset
Management (U.S.) Inc., RBC Global Asset Management (UK) Limited, RBC Investment Management (Asia) Limited, and BlueBay
Asset Management LLP, which are separate, but affiliated subsidiaries of RBC.
This report has not been reviewed by, and is not registered with any securities or other regulatory authority, and may, where
appropriate, be distributed by the above-listed entities in their respective jurisdictions. Additional information about RBC GAM
may be found at www.rbcgam.com.
This report is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should
not be relied upon for providing such advice. The investment process as described in this report may change over time. The
characteristics set forth in this report are intended as a general illustration of some of the criteria considered in selecting
securities for client portfolios. Not all investments in a client portfolio will meet such criteria. RBC GAM takes reasonable steps
to provide up-to-date, accurate and reliable information, and believes the information to be so when printed. RBC GAM reserves
the right at any time and without notice to change, amend or cease publication of the information.
Any investment and economic outlook information contained in this report has been compiled by RBC GAM from various
sources. Information obtained from third parties is believed to be reliable, but no representation or warranty, express or
implied, is made by RBC GAM, its affiliates or any other person as to its accuracy, completeness or correctness. RBC GAM and its
affiliates assume no responsibility for any errors or omissions.
All opinions and estimates contained in this report constitute RBC GAM’s judgment as of June 15, 2018, are subject to change
without notice and are provided in good faith but without legal responsibility. Interest rates and market conditions are subject
to change.
Return estimates are for illustrative purposes only and are not a prediction of returns. Actual returns may be higher or lower than
those shown and may vary substantially over shorter time periods. It is not possible to invest directly in an unmanaged index.
A note on forward-looking statements
This report may contain forward-looking statements about future performance, strategies or prospects, and possible future
action. The words “may,” “could,” “should,” “would,” “suspect,” “outlook,” “believe,” “plan,” “anticipate,” “estimate,” “expect,”
“intend,” “forecast,” “objective” and similar expressions are intended to identify forward-looking statements. Forward-looking
statements are not guarantees of future performance. Forward-looking statements involve inherent risks and uncertainties
about general economic factors, so it is possible that predictions, forecasts, projections and other forward-looking statements
will not be achieved. We caution you not to place undue reliance on these statements as a number of important factors could
cause actual events or results to differ materially from those expressed or implied in any forward-looking statement made.
These factors include, but are not limited to, general economic, political and market factors in Canada, the United States and
internationally, interest and foreign exchange rates, global equity and capital markets, business competition, technological
changes, changes in laws and regulations, judicial or regulatory judgments, legal proceedings and catastrophic events. The
above list of important factors that may affect future results is not exhaustive. Before making any investment decisions, we
encourage you to consider these and other factors carefully. All opinions contained in forward-looking statements are subject to
change without notice and are provided in good faith but without legal responsibility.
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®/TM Trademark(s) of Royal Bank of Canada. Used under licence.
© RBC Global Asset Management Inc. 2018.

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THE GLOBAL

From this global forecast, the RBC GAM

EXECUTIVE SUMMARY 2 CURRENCY MARKETS 51

REGIONAL EQUITY MARKET OUTLOOK

THE GLOBAL INVESTMENT OUTLOOK Summer 2018 I 1

Solid economic growth in sight implement fiscal stimulus, and that

2 I THE GLOBAL INVESTMENT OUTLOOK Summer 2018

THE GLOBAL INVESTMENT OUTLOOK Summer 2018 I 3

Economic forecast (RBC GAM Investment Strategy Committee)

Targets (RBC GAM Investment Strategy Committee)

4 I THE GLOBAL INVESTMENT OUTLOOK Summer 2018

THE GLOBAL INVESTMENT OUTLOOK Summer 2018 I 5

GLOBAL ASSET MIX

CASH 2.0% 1.0% – 16% 3.0% 3.0% 3.0% 2.0% 2.0%

BONDS 43.0% 25.0% – 54.0% 38.0% 39.0% 39.0% 40.0% 40.0%

STOCKS 55.0% 36.0% – 65.0% 59.0% 58.0% 58.0% 58.0% 58.0%

MSCI** PAST SUMMER FALL NEW YEAR SPRING SUMMER

GLOBAL EQUITY SECTOR ALLOCATION

Energy 6.57% 5.11% 6.57% 1.46 100.0%

6 I THE GLOBAL INVESTMENT OUTLOOK Summer 2018

“ At RBC GAM, we have a team dedicated to setting and

THE GLOBAL INVESTMENT OUTLOOK Summer 2018 I 7

8 I THE GLOBAL INVESTMENT OUTLOOK Summer 2018

40-Year Average 9.5% 9.4%

THE GLOBAL INVESTMENT OUTLOOK Summer 2018 I 9

10 I THE GLOBAL INVESTMENT OUTLOOK Summer 2018

THE GLOBAL INVESTMENT OUTLOOK Summer 2018 I 11

GLOBAL EQUITY SECTORS

12 I THE GLOBAL INVESTMENT OUTLOOK Summer 2018

Eric Lascelles Exhibit 1: A tale of two very different years

smooth markets have hit turbulence.

and interest rates are no longer 55

THE GLOBAL INVESTMENT OUTLOOK Summer 2018 I 13

is now fairly old (Exhibit 3). Our bias

U.S. competitiveness but is helpful

for everyone else. Tight conditions

metric. Financial conditions have 98

half of the easing that took place

14 I THE GLOBAL INVESTMENT OUTLOOK Summer 2018

limit how much further yields can

The increase in borrowing costs 60

USD Libor-OIS spread (bps)

has increased considerably (Exhibit 30

financial crisis of 2008-2009, a 10

question the strength of the effect 5 Noise or

THE GLOBAL INVESTMENT OUTLOOK Summer 2018 I 15

From a longer-term perspective,

U.S. unemployment rate (%)

3.5 early 1990s

(Exhibit 11). Several observations 0.5

16 I THE GLOBAL INVESTMENT OUTLOOK Summer 2018

more evidence is needed before a

Second, there is evidence that a If “YES” = faster economic speed limit

Eurozone corporate demand for

loans for fixed investment

(past 3 months, % bal)

potential growth rate has actually

THE GLOBAL INVESTMENT OUTLOOK Summer 2018 I 17

Putting it all together

Annual GDP growth (%)

levels of consumer and business 0.0

lingering boost from easy financial

to the standards of 2018 as the

18 I THE GLOBAL INVESTMENT OUTLOOK Summer 2018